Where Emergency Calls Are Welcome
By Todd Rosenbluth
The Aug. 14 power blackout that hit the Midwest and Northeast U.S. and parts of Canada was a big test for Intrado (TRDO ), a provider of emergency "911" data-management services to telecom carriers. And it passed with flying colors, successfully handling a higher-than-average number of 911 calls despite widespread electrical outages.
The blackout underscored the need for a robust U.S. emergency communications system. We at Standard & Poor's think Intrado should benefit from growing demand for 911 services -- and from its strong competitive position. We also think its shares are favorably valued. Intrado is one of our top picks in our Data Processing & Outsourced Services subindustry group, and it carries our highest investment recommendation of 5 STARS, or buy.
Intrado supports the U.S. 911 emergency response infrastructure for both wireline and wireless telecom networks, allowing public-safety officials to respond to calls for help by hosting and maintaining customer data and system activations. Its data management and delivery capabilities make it possible for emergency service providers to pinpoint both wireline and wireless phone calls at their source. Its 911 service bureau has records in place for over 200 million phone subscribers of its telecom customers under management throughout North America.
CALL ONCE, TELL MANY.
Customers for Intrado's wireline business (which generated 68% of its first-half 2003 revenues) include the four Baby Bells – BellSouth (BLS ), Qwest (Q ), SBC (SBC ), and Verizon (VZ ) -- as well as Cox Communications (COX ) and MCI (MCWEQ ). In addition, Intrado helps six of the seven largest U.S. wireless carriers with their federally mandated Enhanced 911 (E-911) deployments, which include locating the caller's position. Wireless revenues generated 30% of 2003's first-half total.
In late 2002, Intrado launched Intellicast, a mass-notification tool that enables municipalities and the federal government to rapidly distribute critical information in a crisis. Part of a new market segment for Intrado, Intellicast allows for thousands of calls to be placed within minutes. This promising niche is still developing, and we're waiting for contracts to be signed.
We believe that Intrado will be a primary beneficiary of several regulatory trends. We see demand for 911 services getting jump-started if and when Congress passes the Enhanced 911 Emergency Act of 2003 during the current session. The act would authorize $500 million per year for grants to enhance emergency communications services, with matching grants for state and local governments, and require that states certify to the Federal Communications Commission that E-911 fees aren't being used for other purposes.
AN FCC PUSH.
Given the budget shortfalls around the country, we believe this legislation could have a major impact on 911 services, as cities and states have used the fees for other purposes. If the bill becomes a law, which we believe is likely, we expect faster implementation of E-911 to occur. Some carriers have claimed that implementation has been slowed by lack of funding and coordination for public-safety answering points (PSAPs), or 911 call centers.
In addition, in August 2003, the FCC called for state regulators to accelerate the conversion of PSAPs to receive wireless E-911 calls. The FCC will also be hosting an E-911 Coordination Initiative in October "to tackle current deployment issues, accuracy requirements, and additional public education efforts." We believe that a push from the FCC will additionally fuel the still-pending wireless E-911 deployments.
Lastly, we think the Aug. 14 blackout and the successful handling of a higher-than-average number of 911 calls by Intrado should help spur demand. We contend that greater interest will increase from municipalities looking to keep residents alert during a crisis, and we expect contract signings.
In our opinion, Intrado is uniquely positioned to benefit from all these trends. Given its long-term contracts with the four dominant wireline carriers, we believe Intrado should generate a steady stream of income and is unchallenged in the wireline arena. With its sizable database of customer information and the sensitivity of the data it handles, we see substantial barriers to entry for potential competitors in the landline market.
We also believe the risks that one or more of the Bells would look to bring their 911 service in-house -- and end their working relationship with Intrado -- are low. For example, Verizon, the largest Bell with $67 billion in revenues, wouldn't realize material cost savings if it handled roughly $20 million of 911 software and maintenance internally. In addition, we believe that the servicing of 911 calls is too sensitive an area for a Bell company to look to for cost savings.
In the wireless segment, Intrado has existing contracts with six of the seven largest wireless carriers, with T-Mobile the lone national carrier that hasn't entered into an outsourcing contract for E-911. Due to prior mergers, the two largest carriers, Verizon Wireless and Cingular Wireless, have split their E-911 business between Intrado and smaller player Telecommunications Systems (TSYS ). We believe that the limited recent turnover between customers is evidence that Intrado is the leader in wireless E-911. By Todd Rosenbluth
We expect that Intrado's strong relationships with the Baby Bells and its extensive database are positive factors in the negotiation of pending contracts with local municipalities. Emergency notification via telecommunications is still a developing market, so other larger outsourcers may decide to enter it. Plus, the timing of Intrado's contract signings is unknown. However, we believe that competition isn't likely to emerge for at least three years until demand reaches a critical mass to warrant the attention of larger outsourcers such as Affiliated Computer Services (ACS ).
With a roughly $330 million market capitalization, Intrado is still in its growth stage. However, we are encouraged by what we consider to be its strengthening financial position. Cash and equivalents more than doubled, to $26 million, in the six months through June 30, 2003. Even with a roughly $4.5 million preferred stock dividend payout in the third quarter, we expect that cash flow from operations will provide sufficient liquidity for at least the near term.
We're also comfortable with Intrado's total debt leverage of below one times EBITDA (earnings before interest, taxes, depreciation, and amortization) and current ratio of 1.5 as of June, 2003.
On July 24, Intrado posted June-quarter operating earnings per share of 16 cents -– 3 cents above our estimate –- vs. a year-earlier loss of 19 cents. Revenues were up 14%, boosted by an increase in wireless service deployments. Gross margins for the quarter widened to 48% on outsourcing and leveraging of fixed costs.
We project 2003 revenues to climb 22%, driven by steady sales gains to wireline customers and by 60% growth in the wireless segment as Intrado completes more phase one deployments and receives incremental revenues for existing deployments. We also expect growth in the new markets segment as contracts for emergency management are potentially signed in late 2003. We anticipate revenue growth of an additional 19% in 2004, driven by new products and additional wireless deployments.
In 2003, we see full-year gross margins widening to at least 48%, with particular expansion in the wireless and new markets segments, as direct costs are highly scalable. We expect sales and marketing costs to rise 10% as Intrado enters new markets. We see operating earnings per share of 71 cents in 2003 and 99 cents in 2004.
STRONG CASH FLOW.
On a per-share basis, we project Standard & Poor's Core Earnings of 39 cents in 2003, after adjusting for 32 cents in stock-based compensation expense. This represents a difference of 45% from our operating EPS estimate for the year. Although this differential is high, in our view, we note that it's roughly in line with Intrado's peer average and is slightly lower than the 49% differential in 2002. As was the case in 2002, we don't expect any other S&P Core Earnings adjustments in 2003.
Our valuation of Intrado represents a blend of two metrics: p-e-to-growth (PEG) and discounted cash flow. Based on our 2004 EPS estimate of 99 cents and our expected five-year earnings growth rate of 25%, the shares are trading at a PEG of 0.9 vs. the S&P Data Processing & Outsourced Services subindustry's ratio of 1.4. Using the peer group's ratio results in a share price of $35.
Intrado started generating positive free cash flow in 2002. We're projecting free cash flow of $16 million in 2003 and think Intrado will continue to experience growth in free cash flow, given its leading industry position, the market trends in wireless E-911 and mass notification alerts, and cost-containment. Based on our discounted cash flow model, we arrive at an intrinsic value of about $24 for the stock.
Combining the two valuation measures yields our 12-month target price of $30.
In our view, the risks to Intrado achieving our earnings estimates and target price include: regulatory changes, the timing of contract signings, consolidation in either the wireless or wireline industries that could lead to reduced pricing power, geopolitical events, and the company's relatively small size and market capitalization.
Analyst Rosenbluth follows telecom services stocks for Standard & Poor's