Markets & Finance

An Easy Call on Amdocs


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

; recent price, $24.50), which provides customer-management services to telecom-services providers, will continue to benefit from the need for carriers to boost customer service. Competition has intensified in the global wireline and wireless markets, and we believe this creates growth opportunities for companies such as Amdocs that can help the carriers reduce churn through comprehensive billing and customer care.

We believe that earnings and free cash-flow growth prospects aren't reflected in Amdocs shares, which carry Standard & Poor's highest investment recommendation of 5 STARS, or buy.

GLOBAL REACH. Amdocs targets its broad suite of integrated customer-management services to industry-leading telecoms in North America, Europe, and the rest of the world. It provides customers with a portfolio of integrated billing and customer-relationship-management (CRM) products. It believes that its systems reduce operational costs, support customer retention, and aid the rollout of new marketing packages.

Amdoc's core product, its Integrated Customer Management (ICM), consists of Amdocs Enabler, which supports prepaid and postpaid billing of voice and next-generation service, and Amdocs ClarifyCRM, which provides help in managing customer relationships through service and support, sales and ordering, and marketing and analytics. In addition, Amdocs offers an advanced line of products that supports directory-publishing operations, including Internet directories, as well as traditional Yellow and White Pages. Amdocs generates revenues from services (95.5% of the total in the fiscal year ended September, 2003) and licenses (4.5%).

Customers include global communications leaders, as well as other network operators and directory publishers in the U.S. and worldwide. In fiscal 2004, Nextel Communications (NXTL

; S&P rank 5 STARS; $26.37) and its subsidiaries accounted for 15% of revenues. Amdocs derived 11% of its revenues from Bell Canada and SBC Communications (SBC

; 2 STARS, avoid; $25.35), which owned about 9% of Amdocs shares as of September, 2003. In fiscal 2003, nearly 30% of revenues came from European customers, including Vodafone (VOD

; 3 STARS, hold; $25.50), Deutsche Telekom (DT

; 3 STARS; $19.07) and Cegetel.

SEC PROBE. The extent of services provided varies from customer to customer. Some providers prefer a highly customized approach, with extensive modifications to ICM and a significant level of ongoing support. In recent years, more customers have chosen to implement standard, preconfigured products with limited customization and a lower level of ongoing support.

Once a system is operational, Amdocs is generally retained to provide maintenance, enhanced design, and operational support, leading to incremental revenues and longer-term relationships. Its professionals often work at the offices of telecom customers. Amdocs also maintains developmental facilities in Israel, the U.S., Cyprus, Ireland, and Canada. In July, 2003, it purchased Bell Canada's 90% ownership interest in Certen, which Amdocs had helped to form in January, 2001. The $66 million cash acquisition of Certen expanded the managed services offerings.

The Securities & Exchange Commission is currently conducting an investigation into events leading up to Amdocs' June, 2002, announcement that detailed its fiscal 2002 revenue projections. No new information has been provided on this investigation.

EXPANDING CLIENTS. In the quarter ended September, 2004, cable carriers, in our view, sought to expand their broadband customer bases and bundle video services. In an effort to combat strong competition, wireline carriers are similarly rolling out new bundled products and are looking for customer-retention support, without increasing their operational costs. At the same time, wireless carriers are seeking to foster loyalty among existing customers.

We contend that Amdocs is well positioned to benefit from these trends as it provides companies with a portfolio of billing and CRM products designed to help link customer-facing business processes and across back-office and front-office systems.

Over the next 12 months, we see Amdocs winning more contracts with top-tier carriers and expanding its relationship with existing customers. We view positively its recent contract extension with top customer Nextel. In addition to continuing to provide customer-care support that has helped Nextel's well-below-average customer churn, Amdocs will aid the carrier's wireless broadband trial.

This extension comes just a couple of weeks after Amdocs announced its successful rollout of customer care and billing software for Russian telecom carrier VimpelCom. Amdocs' global customer base also includes European leaders Vodafone (VOD), Deutsche Telekom, and Cegetel.

CINGULAR ADVANTAGE. Amdocs will be reporting its fourth-quarter fiscal 2004 (September) results after the market closes on Wednesday, Nov. 3. While we expect it to highlight these signings during its earnings call, we hope to hear how developments with large client SBC Communications are progressing. In addition to wireline support, Amdocs provides billing and customer care services for SBC's 60% owned Cingular Wireless, which just last week closed its acquisition of AT&T Wireless (ATT); the minority portion of Cingular uses a different billing provider.

The customer base of combined Cingular Wireless has nearly doubled to more than 46 million subscribers, but churn has been rising at both Cingular and AT&T Wireless. With Cingular intent on moving most AT&T Wireless customers onto the Cingular platform over the next 12 months, we see the likely influx of new wireless subscribers on Amdocs' system providing incremental revenues to the company. We believe that Amdocs will be a beneficiary, as Cingular needs to improve its customer-retention efforts in 2005, in our view, if it's to remain ahead of peer Verizon Wireless (VZ) as the largest U.S. wireless carrier.

We believe that Amdocs has a highly scalable business model that's dependent on greater spending by telecom carriers. We forecast revenues of $454.3 million in the September quarter, up 10% from the prior year and 1% from the June quarter. We expect growth will come from both an increase in license revenues and from the larger services component.

WIDENING MARGINS. In fiscal 2005, we see revenues climbing 6% from the $1.78 billion expected in fiscal 2004. In the June quarter, Amdocs announced that its relationships with British Telecom and Vodafone have been expanded to include more services offered in more markets, which we believe will help to drive revenue growth.

Also incorporated in our estimates for fiscal 2005 revenues is an expected $85 million related to new customers moving onto SBC's wireless billing platform. As we have noted, we believe that SBC's Cingular Wireless will begin moving billing and customer-care services for former AT&T Wireless customers onto the Amdocs platform. We will update our estimates following Amdocs' Nov. 3 conference call.

We expect Amdocs' fiscal 2004 gross margin to narrow slightly, to 37%, but we see the margin widening sequentially in the September quarter on anticipated revenues increases and a more favorable product mix. We see operating margin widening to approximately 18% in fiscal 2004, from 16.5% in fiscal 2003, as selling costs are well contained. We project that operating margins will widen further in fiscal 2005 to 19%.

We expect operating earnings per share (EPS) of 31 cents in the September quarter, before one-time items for acquisition-related costs and related tax effects. For fiscal 2005, we project EPS of $1.33, up from an expected $1.16 in fiscal 2004. Our calendar-year EPS forecast for 2005, which includes our projections for the December 2005 quarter, is $1.38. For comparison purposes with billing and customer care peers, we use calendar EPS estimates.

DESIRABLE DIVERSITY. We estimate Standard & Poor's Core Earnings of $1.04 per share in fiscal 2004 and $1.21 in fiscal 2005. In fiscal 2004, our S&P Core EPS estimates include estimated stock-based compensation expense of about $24.5 million (12 cents per share). In our opinion, the divergence between Amdocs' operating and S&P Core Earnings estimates is lower than that of other technology companies in Standard & Poor's coverage universe.

Our 12-month target price of $30 values Amdocs shares at 22 times our calendar year 2005 EPS estimate of $1.38, or a p-e-to-growth ratio of 1.5. While this is a slight premium to our peer group of billing and customer-care providers, it's similar to that seen in prior years, and we believe warranted in light of Amdocs' diversified customer base and wider operating margins. Our

discounted cash-flow model supports our valuation and target price.

Risks to our recommendation and target price include the timing of contract signings, a potential slowdown in telecom spending, a potential acquisition in the cable billing space, the company's international exposure, and the stock's high

beta. Analyst Rosenbluth follows stocks of telecommunications services companies for Standard & Poor's Equity Research Services


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