University of Rochester
. Mark Kastan has covered competitive local exchange carriers, or CLECs, for
Credit Suisse First Boston
since 1999. Previously, he spent nearly six years at
. Before that, he worked on the buy side for 10 years at
Industry Outlook and Style
The alternative carrier industry is so new that the players do not yet post positive earnings. So how can investors choose the best companies?
Mark Kastan separates the wheat from the chaff in this industry by analyzing whether management has met or exceeded expectations in areas that
be measured. His rationale is simple: If companies have executed according to plan so far, the likelihood is that they'll continue to do so. For him, the most important measurements an investor should look at in the absence of earnings are revenue growth projections and
The two companies that Kastan cites as having best executed their strategies -- and that he's been calling his favorite stocks for more than a year are --
. Both companies were stellar performers in 1999: McLeod climbed 277%, while XO skyrocketed an even-more-impressive 485%. This year, however, both have stumbled. McLeod closed on Oct. 30 at $18.81, down 4.1% since the beginning of the year. The stock has shed half of its value since March. XO closed same day at $29.19, down nearly 29.7%.
Recent performance notwithstanding, Kastan calls XO "one of the best-managed companies in the sector." He notes that XO has a large portfolio of fixed wireless licenses and contends that it has "the best portfolio of broadband assets." In addition, he praises XO's purchase of network capacity from optical fiber network service provider
, which he asserts that XO received at "an extremely attractive price." Thanks to this transaction, XO will have at its disposal access to a state-of-the-art broadband network comprising two-thirds of the U.S. market as well as 21 major cities in Europe.
The analyst, who heads coverage of CLECs on CSFB's 10-person telecom team, asserts that McLeod has an equally "terrific" management. The company, he says, has a fully funded business plan and it has done a good job of amassing market share in core areas. In addition, he observes, "McLeod's new national data strategy should help sustain growth and boost margins over the long term."
In the past few months, Kastan has dropped coverage of some weaker names, such as
, whose back office systems and access to capital were insufficient. In fact, GST has already declared bankruptcy.
Of the 15 companies left in his universe, the CSFB analyst has buys or strong buys on 13. Besides XO and McLeod, these include
. (CSFB has banking relationships with each, and both the firm and Kastan have equity investments in WinStar.)
The alternative carrier industry is growing apace, both in terms of revenue and market share, Kastan contends. "CLECs have added between 2 and 2.5 market share points per year for the past two years, and now hold at least 6.5% of the $190 billion local and long-distance voice and data market. By 2008, we expect pure CLECs, as well as the CLEC divisions of the large long-distance companies, to have accumulated approximately 25% of local market share." (
, which bought
, which bought
, have large CLEC divisions.)
Kastan is unreservedly bullish on the sector's strongest names: "I see no evidence that's led me to question the strength and sustainability of the secular growth case for this sector," he says.
Favorite stock for next 12 months:
McLeod USA; 12-month price target: $39
"McLeod's 1999 revenue was $909 million, which we anticipate will climb to $1.4 billion this year and $1.9 billion next year. McLeod continues to strengthen itself with an ongoing stream of great new hires as it expands its plan. Recently, for instance, it brought in a new senior team to focus on the data services side."
Rate Their Stock Picks:
Which stock do you like best?
Henry: XO Communications
Kastan: McLeod USA
Kennedy: Time Warner Telecom