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Amdocs' Winning Ways

By Todd Rosenbluth Standard & Poor's Equity Research believes Amdocs (DOX

; recent price, $26), a supplier of billing and customer relationship management products to telecom-services companies, will continue to be a beneficiary of the long-term trends in the communications industry. The company's skills in implementing complex, large-scale integrated customer-management programs will become more in demand, in our view, as communications service providers combine a range of offerings and systems to support them.

In our opinion, Amdocs' complex products will help companies in the still-consolidating industry improve customer loyalty and reduce operating expenses by utilizing customized billing and care services. We see Amdocs as the leader in this market and think it will continue to grow by expanding its relationships with existing communications customers and signing new deals. We believe the stock's recent price decline offers an enhanced opportunity to invest in an undervalued outfit with strong prospects. Our rating is 5 STARS (strong buy).

Amdocs targets its broad suite of integrated customer management services toward industry-leading communications-service providers in North America, Europe, and the rest of the world. Its products are designed to help link customer-facing business processes and touch points across back-office and front-office systems. Amdocs believes that its communications customers are looking for systems that reduce operational costs, support customer retention, and aid the rollout of new marketing packages.

TOP CLIENTS. The company's core product, the Integrated Customer Management offering (ICM), consists of Amdocs Enabler, which supports pre-paid and post-paid billing of voice and next-generation service, and Amdocs ClarifyCRM, which provides support for managing customer relationships through service and support, sales and ordering, and marketing and analytics. In addition, the company offers products that support directory-publishing operations.

The company's customers include global communications leaders as well as other network operators and directory publishers in the U.S. and worldwide. In fiscal 2004 (ended September), Amdocs' top five customers accounted for 61% of its revenue, and included Bell Canada (BCE

; 4 STARS, buy; $24), Nextel (S

; 4 STARS; $23), and SBC Communications (SBC

; 3 STARS, hold; $23), with each accounting for more than 10% of revenues. In the nine months ended June, 2005, approximately 67% of revenues came from North American customers and 25% from European customers, including Vodafone (VOD

; 3 STARS; $25), Deutsche Telekom (DT

; 4 STARS; $18), and Cegetel.

Some service providers prefer a highly customized approach, with extensive modifications to the ICM and a significant level of ongoing support. But in recent years, more customers have chosen to implement standard, pre-configured products, with limited customization and a lower level of ongoing support. Once a system is operational, the company is generally retained to provide maintenance, enhanced design, and operational support, leading to incremental revenues and longer-term relationships. Amdocs' professionals often work at the offices of telecom customers. The company also maintains developmental facilities in Israel, the U.S., Cyprus, Ireland, and Canada.

BROADBAND BUNDLE. In July, 2005, Amdocs entered a new market by acquiring DST Innovis, a provider of billing and customer care to broadband-media companies, for $238 million in cash. DST's customers include Comcast (CMCSA

; 3 STARS; $27), Cablevision (CVC

; 3 STARS; $28), and DirecTV (DTV

; 3 STARS; $14.) We believe Amdocs will have success serving these customers with its broad suite of products. In August, 2005, it acquired Longshine Information Technology, a privately held Chinese customer-care provider, for approximately $30 million.

As of June, 2005, the SEC was conducting a multi-year private investigation into events leading up to Amdocs' June, 2003, announcement that detailed its fiscal 2002 revenue projections. No further update has been provided on this investigation.

In the quarter ended September, 2005, cable carriers have sought to increase their broadband customer bases and have bundled video services. Wireline and wireless carriers are similarly rolling out new bundled products in an effort to combat strong competition, and this year, the carriers have engaged in merger and acquisition activities. We believe companies are looking for customer-retention support while at the same time reducing their operational expenses.

ROBUST PIPELINE. We contend that Amdocs is well positioned to benefit from these trends, as it provides companies with a portfolio of pre-integrated billing and customer relationship management products. Over the next 12 months, we see Amdocs winning more contracts with top-tier carriers and expanding its relationship with existing customers.

In the past several quarters, the pipeline has been robust and has grown across all geographies. Given recent developments in new markets such as Russia and China, we believe the company's pipeline continued to grow in the September quarter. Subsequent to the end of the quarter, Amdocs announced the expansion of its relationship with Telia Mobile Denmark to help the European carrier consolidate legacy systems and migrate acquired wireless customers.

Furthermore, the company's business with U.S. wireless carriers Cingular and Sprint Nextel is growing following consolidation. During its quarterly conference call on Oct. 19, Cingular noted that one year into the merger with AT&T Wireless, approximately 75% of the acquired customers have been migrated onto Cingular's billing system, which is primarily handled by Amdocs.

MERGER MATTERS. With Cingular intent on bringing the remaining customers onto the Cingular platform over the next 12 months in an effort to create an improved customer experience, the likely influx of new wireless subscribers on Amdocs' system should be incremental to the company's revenues. We believe Amdocs will be a beneficiary, as Cingular needs to improve its customer-retention efforts in 2006 if it is to remain ahead of peer Verizon Wireless as the largest U.S. wireless carrier.

We believe Amdocs will also gain share in 2006 from the combination of Sprint and Nextel, as the newly merged carrier looks to widen margins and decrease customer churn. A decision should be forthcoming by the end of 2005 about the billing business for Sprint's post-paid wireless customers. We think Amdocs, which has a long-standing relationship with Nextel, will win the majority of the Sprint business over rival Convergys (CVG

; 2 STARS, sell; $16), though we expect Amdocs to grant modest price concessions. We anticipate Sprint Nextel's migration to a single standardized billing platform will be similar to the approach used by Cingular.

Amdocs is scheduled to report its fiscal 2005 (ended September) fourth-quarter results after the market close on Nov. 9. We expect the company to provide an update on developments in the Sprint Nextel matter, as well as discuss how its relationship with large client SBC Communications is progressing. (In addition to rolling out new products, SBC is nearing the closing of its planned merger with AT&T Corp., subject to approvals.) We see Amdocs reporting operating EPS of 38 cents in the September quarter, before one-time items for acquisition-related costs and related tax effects. We anticipate revenues of $573.3 million for the quarter, up 13% from the June quarter and 27% from a year earlier.

NARROW MARGINS. Expanded relationships with British Telecom and Vodafone, along with contract wins in the first half of fiscal 2005 with SBC Communications, should help drive revenue growth. We see the July acquisition of DST Innovis adding revenues of approximately $52 million in fiscal 2005 and $219 million in fiscal 2006. Our estimate includes the expected positive impact of new customers migrating to SBC's wireless billing platform but doesn't include additional business from the Nextel relationship. SBC's Cingular Wireless began moving billing and customer-care services for former AT&T Wireless customers onto the company's platform in early 2005, and we see the process taking about 18 months.

We look for operating margins to narrow sequentially in the September quarter with the integration of lower-margin new broadband operations. For fiscal 2006, we see margins expanding throughout the year on anticipated revenue increases and a more favorable product mix, despite wage increases. We see fiscal 2006 margins of 17.7%.

We project operating EPS of $1.42 in fiscal 2005 and $1.63 in fiscal 2006, up from $1.16 in fiscal 2004. Our estimates don't include potential acquisition-related charges. Our calendar year EPS estimate for 2005, which includes our projection for the December, 2005, quarter, is $1.64. For comparison purposes with our peer group, we use calendar EPS estimates.

PEER COMPARISON. Based on S&P Core Earnings methodology, we see the quality of Amdocs' earnings as similar to that of its competitors. In our view, the use of unexpensed stock option grants to compensate managers and officers is widespread throughout the information-technology sector. After adjustments to the company's GAAP-based net income to reflect the expensing of stock options grants and including acquisition-related charges that are excluded from our operating earnings calculation, the company's fiscal 2004 net income would have been reduced by 15.5%, to 93 cents.

For fiscal 2005, we're projecting S&P Core EPS of $1.29, a 9% reduction from our $1.42 estimate. In fiscal 2006, we project S&P Core EPS of $1.49, including 14 cents for stock option expenses.

Using our 2006 calendar estimates, Amdocs was recently trading at a price to sales multiple of 2.1 times, essentially in line with peers, and a p-e multiple of 16 times that's below the average of its peers. Our 12-month target price of $34 values the shares at 21 times our calendar year 2006 EPS estimate of $1.64, or a p-e to growth rate of 1.5.

This is still a slight discount to our peer group of companies that provide enhanced services for communications companies. We believe this market is discounting the company's strong fundamentals, including its diversified customer base and relatively wide operating margins. We believe Amdocs' strong cash position, which we estimate at about $1 billion including the DST Innovis acquisition, also supports the shares.

GAUGING THE BOARD. Amdocs' corporate-governance practices have a mixture of positive and negative aspects, in our opinion. In accordance with the NYSE rules, the majority of the directors are independent and the company lists its corporate governance, audit committee, and compensation committee guidelines on its Web site. The chairman of the board is an independent director, and the chairman of the audit committee has financial-management experience.

However, a few of the directors hold or have recently held senior level positions with SBC and Comcast, two of Amdocs' customers. In addition, the company has a long history of excluding stock-option expenses.

Risks to our recommendation and target price, in our view, include the timing of contract signings, pricing pressure, a potential slowdown in telecom spending, the integration of Amdocs' recent acquisitions of DST Innovis and Longshine Information Technology, the company's international exposure, and the stock's high beta. Analyst Rosenbluth follows shares of telecom services companies for Standard & Poor's Equity Research Services

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