Merrill finds Amdocs AT&T deal outweighs Sprint risks

Analyst Tal Liani: We see very few large transformational opportunities left.

Merrill Lynch reiterates its "Buy" recommendation Amdocs Ltd. (NYSE: DOX) at a target price of $43, compared with Friday's closing price of $28.90, after a 5.3% gain.

Merrill Lynch Tal Liani expects Amdocs to respond to 2008 growth acceleration and predicts a GAAP-based earnings per share of $1.87 in 2008 and $2.18 in 2009.

Liani notes two risk factors for Amdocs. "First, looking around the globe, we see very few large transformational opportunities left, similar to the contracts Amdocs won in the US in 2005/2006. Going forward, the company will need to extract more revenues from existing customers; wait for carriers to start using outside vendors for their billing and customer care systems; or make an acquisition in order to grow the addressable market. While we believe that Amdocs has no major acquisition in the pipeline, we wouldn’t be surprised to see such a move over the next 12 months.

"The second risk factor relates to Amdocs’ exposure to Sprint-Nextel Corp. (NYSE:S), at 13%, or about $400 million, of Amdocs’ annual revenue. We believe that 60-65% of this revenue represents an on-going charge per customer (per bill) that could prove to be resilient under almost any worse case scenario. The other 35-40% of revenues represents a more “discretionary” part related to consulting, deployment charges, services, special projects, and other fees. We see no imminent risks to the second type of revenues, yet we could see pressure to this revenue component in bad case scenarios (approx 5-6% of revenues). We note though that Sprint is very committed to conclude the migration of customers to the new system by mid-2008. It will enable the carrier to shut down one of its two service centers and reduce the workforce by thousands of employees (in excess of 5,000). Lastly, management noted in the past that its 2008 guidance includes only a conservative contribution from Sprint."

Liani also sees short-term positive factors at Amdocs, which he considers "more important". "Over the last year, Amdocs won two major seven-year outsourcing deals with AT&T (NYSE: T), which we estimate to be over $2.1 billion combined. We estimate the first contract at $600 million, involving the outsourcing of an enterprise order management system to Amdocs. We estimate the second contract at $1.5 billion, related to the outsourcing of a billing and customer system of AT&T’s long-distance business. In addition, we believe AT&T U-verse IPTV project continues to grow and generates good flow of business to Amdocs."

Liani adds, "We acknowledge the risk to margins, given the headcount increase that typically accompanies outsourcing deals. However, management reiterated that the risks to margins are already built into estimates, with no new data center required in the intermediate term (similar to historical outsourcing deals). We believe AT&T's strength is the main reason for the expected acceleration in the revenue growth from 7.4% year-on-year in first fiscal quarter to about 13% by the fourth fiscal quarter. Margins should also inch up every quarter."

Liani notes, "We believe Amdocs has managed to sell its OSS solution to one of the North American carriers (AT&T in our view), which is the first time the company managed to sell Cramer’s system bundled with the traditional services model of Amdocs. Time will tell whether this major deal opens up new opportunities. In addition, we believe Comcast has selected Amdocs’ platform for its 'strategic convergence platform'. However, unlike the type of quick migration plans seen with telcos, we believe Comcast Corporation (Nasdaq: CMSCA) has decided to make the migration gradually, spread over many years. We note that CSG Systems Inc. (Nasdaq: CSGS) also received a contract to modernize its own system with Comcast, suggesting that indeed the carrier plans to make a very slow and gradual move of customers to Amdocs’ system, probably only putting new subscriber additions on Amdocs’ systems and making no changes to the existing subscribers. Given the high churn on MSOs’ networks, the migration to Amdocs’ systems should happen naturally over a few years."

Liani concludes that Amdocs' multiples are at historical trough levels. The current forward multiple of 12x represents the lowest level in the past five years. We therefore expect the stock to respond to the revenue/EPS growth acceleration throughout 2008 and believe the risks at Sprint are adequately reflected in the share price."

Published by Globes [online], Israel business news - www.globes-online.com - on March 23, 2008

© Copyright of Globes Publisher Itonut (1983) Ltd. 2008

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