Description
It's a unusual time to tout a telecom, but Touch America (TAA), with a price below cash, a debt free balance sheet, and a modern, national fibre optic network focused on commercial data customers is well positioned to benefit from industry consolidation and market recovery.
1. Debt Free: The company is now debt free having completed the sale of its utility assets.
2. Cash: Cash balance of $112m as of 6/30/02; market cap of $88 million.
3. Network: Its fiber optic network is currently serving 125 major US markets. Touch America’s network is 85% complete; it will have a coast-to-coast network at the end of the year. The network cost approximately $1.1 billion to build and was built at relatively low cost with state-of-the-art fiber (much of it OC192).
4. Revenue: Current monthly revenue run rate of $28m.
5. Capex: Company believes it can limit further capex this year to as little as $10m.
6. Business Focus: Company has shifted focus to more profitable commercial data business; its target market is Fortune 500 companies and strong regional companies. It expects significant revenue growth from current clients. TAA is reducing its % of revenue from low-margin phone services and is increasing its "on-network" data traffic with the completion of its network ("off-network" traffic, arranged through another company or RBOC, is usually on break-even terms).
7. Cost Cutting: With cost-cutting already implemented, Company could be cash flow neutral by early 2003 based on conservative demand growth.
8. Price Stabilization: Prices have stabilized after 1 1/2 years of bandwith price erosion. The company noted there was no change in price (voice, private line, Access, ATM/Frame relay or internet) during Q2 2002. The few survivors in this industry may reap the rewards when companies begin to invest in broadband intensive services and technologies.
9. Telecom Supply/Demand: The major risk factor is the supply demand equation for broadband capacity:
a) No single company has a network across 100% of the country. There are six companies that provide similar services; four of these are in bankruptcy.
b) While there is a huge amount of fiber optic cable in the ground, the real cost is to create "lit cable" -- the cost of lighting is approximately 85% percent of the fixed cost. Also, much of the "dark" fiber laid by AT&T, Worldcom and others would not be cost-effective to light.
c) There is more lit capacity than is currently needed -- but very hard to say how much.
d) A danger is that the glut of lit fiber restarts price competition; a number of companies at or near bankruptcy could sell capacity at a loss to grab market share and revenue. There have been no signs of this occurring.
e) However, prices seem to have stabilized so that unit demand increases should drive revenue growth.
f) Unit demand for private line, frame relay and ATM services has been growing at an average rate of 30, 66 and 77% respectively over the last five years. This growth is without any material impact from such broadband-intensive uses as teleconferencing, IP telephony, distance learning, video on demand, etc. - all of which are just a matter of time. We would guestimate that only when TAA and its competitors have EBITDA margins over 20-25% (Q1 2001 margins were 15-20%), enough confidence in this sector will be restored to finance new capital expenditure. It would take 1 to 2 years to bring that additional capacity to the market. With those margins, TAA would have $67-84m annual run rate EBITDA at annualized June monthly revenue rate.
10. Litigation: TAA has ongoing litigation with Qwest which would be in both parties' interests to resolve. In addition, TAA has been hit with several class action lawsuits relating to its divestiture of utility company (Montana Power) assets. Qwest has pending Interlata services applications (Section 271) that might be effected by these outstanding claims - therefore, they have compelling reasons to put this long-standing litigation behind them. TAA believes they are owed $90-200m by Qwest (though a Qwest bankruptcy would limit their recovery, if any).
Despite the imperfect information in this market, we believe that the US telecom market will recover and Touch America is well positioned to emerge as a solid performer or consolidation target.
Catalyst
TAA is a rare debt-free telecom, with a modern network and $112m in cash - at $74.0m market cap a potential acquisition target at a deflated price.