Note: "Before IPO" and "After IPO" measure the use of the proceedings to enhance revenue growth. A small difference between the two Xs means funds from the proceedings probably will have little effect on the index.

Rating Scale

Prediction
The underwriters will be singing the praises of the vibrancy of the telecommunications industry and of this company with its stupendous growth. Little will be said about the low margins, the decentralized control, the unpredictable future in the face of much stronger competitors, and the mountainous debt. In particular they will not theorize about the impact on stock price if they clear the debt with stock. Nor will they explain how the union of weak companies creates a strong company.

Still, none of it will matter. The stock will open probably at $15 and will stay steady or move up 4 or 5 points. It’s performance will be decided by the machinations of the underwriters. Twelve to 15 months later, when reality sets in, it will sink below $10.

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"The Company was formed by Ronald S. Lauder and Itzhak Fisher in 1994 to capitalize on the opportunities created by the growth, deregulation and profitability of the international long distance market. The Company has grown rapidly through acquisitions, strategic investments and joint ventures as well as through the start-up of its own operations in key markets."

Summary Of Financial Data
In thousands except for Net Income Per Share.

Balance Sheet Data

As of June 30, 1997—

Use Of Proceeds

Mergers and acquisitions, capital expenditures, and working capital.

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Comments
RSL Communications, Ltd. has not been timid in its growth. It opened its doors for business three short years ago (’94) and did $4.7 in sales. By the end of ’96 it was boasting revenues of $113 million and the ’97 projection reaches to $218 million. In the meantime it has swept into its camp 14 other companies across the globe from the U.S. to Japan and from Finland to Venezuela in a display of consolidation that is breathtaking in its speed. It has set up interconnection agreements with 16 foreign carriers for entry into still more countries and is strategically positioning itself to move out aggressively in all these markets as they continue to deregulate.

The Company has worked every angle of the startup with the artistry of a world-class baton twirler—situating itself as a holding company in Bermuda, lassoing in some shi-shi underwriters, launching simultaneous IPOs both in the U.S. and "internationally" to leave no dollar, franc, mark, or pound uncollected.

The current, preliminary version of the prospectus doesn’t state the amount of stock to be issued or its opening price, but it’s safe to say the amount will be large and the price high. Proceedings of $20 or $30 million would have no appreciable effect on their operation. They are seeking funds on the order of $150 million, and they will get it. Why?

Stock Stock Stock
Hundreds of millions of dollars are poised to be shifted around in a display of empty entrepreneurialism at its finest. This Company was formed with stock, is operated with stock, will grow with stock, and will pay its burgeoning debts with stock. Two hundred million shares have been authorized. Although they’ll start out modestly in its release, maybe 10 million shares at $15, they will return rapidly to the trough with numerous private and secondary offerings of comparable size in a mad dash to achieve some kind of critical mass.

In the telecommunications industry one must not take too seriously athletic leaps in revenue, less so when it’s arrived at through acquisition. Fundamentally, telecommunications is a commodity business whose gross profit margins are only barely adequate for even the most matured of companies, and not at all adequate for the new entrants. RSL Communications showed a 14.6% gross profit margin in ’96, which in ’97 has dropped to an even thinner 11.6%. These are not margins deserving of much enthusiasm. They’ve admitted in some cases being unable even to generate a gross profit. That is to say, their costs per billable minute actually exceed the revenue received.

A Patchwork Of Companies
The concatenation of several independent companies, each one of which loses money, creates a single company of high revenue, which loses money. In 1994, they showed an operating loss of $2.8 million loss. In ’95 the loss was $9.4 million, in ’96, $30.6 million, and in the first half of ’97 they’ve already lost $31.5 million. Is there any reason to believe that circumstances will change to stem the tide?

The investor should not confuse what this company does with being high tech. It has no technology of its own to speak of, few if any patents, and no R&D. It sells a service that many others sell—long distance time. It does so at commodity-level prices using leased lines and in a way that differentiates itself little from any other competitor.

The Company further carries a burdened that most others don’t. It has acquired a patchwork of companies, each enduring the vagaries of telecommunications in its country, some with greater deregulation, others less, all operating in their own way, with their own corporate culture, with their own accounting systems and pricing structure, and with sales, expenses, and cash flow denominated in the local currency. The heterogeneous mix would seem to be a management nightmare.

Kicked Back In Bermuda
Far-flung operations are never easy to bring under centralized corporate control. At best, it takes years to achieve and sometimes is never successful. However, the Company has a neat way to finesse this enormous problem. It brushes off centralized corporate control.

RSL Communications, Ltd., situated in carefree Bermuda, is a holding company whose primary effort is to make acquisitions, structure them as independent subsidiaries, and hold their stock. All the acquisitions are bound together by a common name and an amorphous entity called RSL-Net, which is in various stages of development. RSL-Net apparently consists mainly of switches and routing algorithms, and perhaps it includes part ownership in fiber-optic cable. As is commonly done the switches are placed in large cities around the world. They become the exit or entry point for calls leaving or entering the country. The switches would indeed provide a measure of independence along the path that a telephone call makes, and this in turn should help improve margins. All companies making a play for a serious position in the market will have switches and routing algorithms. So far as it goes, this move to impose a so-called net on the operations of its subsidiaries is understandable. The extent to which it improves margins, though, remains an open question.

A Commodity Business
The Company still needs to lease transmission lines, most of which are owned by major competitors, such as AT&T, MCI, Teleglobe Canada, British Telecom, France Telecom, and Deutsche Telekom, all multibillion dollar players. The costs to lease their lines depend on the amount of transmission capacity for a given market. Excess capacity for the market means the Company should negotiate a long-term lease when the costs are lowest. Conversely, limited capacity suggests that a short-term lease is best in order to avoid getting locked in if rates come down. Since margins are so low, these issues become accentuated in importance, yet they are difficult to optimize.

The other difficulty with leased lines is the requirement to pay under-utilization costs when that occurs or the need to lease more lines at undoubtedly higher costs when transmissions exceed capacity.

Such are the nuances, with which this price-sensitive industry must deal. The problem can only be compounded for the Company, because it suffers from global breadth without depth. It will rely on leased lines into the very distant future, and this will be one of the many reasons its margins stay low.

Deregulation of the telecommunications industry is both a blessing and a curse. There’s no doubt that consumers benefit enormously from deregulation. It has motivated the creation of hundreds of new companies with new products making the playing field more competitive than ever before. But the driving down of prices and fragmentation of the market cause the entire industry to suffer from lower revenue per billable minute. For example, "One Plus" dialing for long distance in the U.S. has brought down consumer costs nearly to wholesale levels and has virtually eliminated pricing changes as a function of distance. Brand name will hold no sway over customers who can shave off another fraction of a penny with no more effort than the dialing of a different code.

Over the next 3 or 4 years similar competitive pressures will force this approach into the international long distance arena creating a severe commodity climate with negative consequences for revenue generation. Especially hurt will be small and weak companies whose margins already are razor thin.

Stiffer Competition On The Horizon
It will only get worse when the U.S. regional Bells enter the international long-distance market. They are big, sophisticated operations with substantial resources and a track record of net income. We can expect the impetus toward consolidation to increase by their ability to out-market and outlast smaller players.

As worldwide deregulation continues, competition within each country also will increase causing further fragmentation of the markets. Getting ahead of the flurry is one of the reasons for the Company’s rush to stake out a position in key countries, especially in the European Union, which constitutes the largest long distance market in the world. This strategy is not without risk. The pace of deregulation in the EU is slow and inconsistent among countries. The effort could take years and in the end not be sufficient to justify the Company’s approach. Competition will be intense, major players in the world will be involved, and the margins will be low. Those who survive will need some fundamental advantages, which the Company so far cannot claim.

$312.2 Million In Debt: What, Me Worry?
Investors should note that the Company has saddled itself with $312.2 million in debt against shareholders equity of $18.7 million. This doesn’t phase the Company in the slightest. It "expects to incur substantial amounts of additional indebtedness in the future." Given its momentum in acquiring companies and spending money, we can expect the amount of debt to double. Meanwhile the interest alone on the debt could exceed the Company’s ability ever to pay, even in the good times when showing a positive EBITDA, which currently it does not. And it can be stated with absolute assurance that no earnings, which the Company could ever hope to muster, would be enough to reduce the principal any appreciable amount.

Guess Who’s Going To Pay Off The Debt?
Of course, it will be reduced through the sale of stock. A $600 million debt with a $10 stock in private offerings needs only 60 million shares to resolve; they have 200 million shares allocated for just such contingencies. It’s unlikely that the dilutive effects of this much stock in play will be countered by increases in net income. Investor enthusiasm instead will be pumped with press releases of an unending flow of acquisitions and dazzling increases in revenue. Continuing losses will be brushed off as the necessary concomitant of growth.

Income? Oh Yeah
Somewhere along the line the Company will have to confront the margin issue. It does not appear, though that they have the staff or that they wield sufficient control over their distant operations to address these strategic details. Even in one of their most crucial markets, the U.S., the revenues fail to reflect a strongly established position. As much as 63% of the revenue comes from carrier customers. These customers are not the small to medium businesses whom they seek but are, rather, other telecom competitors who lease the switch for their own customers at rock-bottom margins. The advantage to the Company is the increased utilization of a switch. However, a high percentage of revenue from carrier customers means a lack of penetration into their target market. Acquisitions in other parts of the world will do little to grow the customer base in the U.S.

Comparing Against Other Companies
It’s useful to compare the Company against others in the telecom industry of similar size. Tele-Save Holding Company shows net income of a remarkable $20.2 million on revenues of $232 million. Their stock price currently is near its 52 week high at $20 5/8, which delivers $0.31 in earnings per share on 65.3 million shares outstanding. They apparently have little debt.

ACC Corp is at a robust $30 15/16 on net income of $7.8 million with $309 million in revenues. They showed earnings of $0.46 against 16.8 million shares outstanding. For the industry their gross margins have been quite good, between 38 and 45%. However, they’re bracing for a decline as competition picks up and regulations change. ACC Corp started in the U.S. market in 1982. When compared to Tele-Save Holding Company its stronger stock position may be attributable in part to the limited amount of tradable stock.

Midcomm Communications Corp is currently near $7 3/4 per share with a 52 week high of 16. In 1996 revenues were at $149 million, and they showed a net loss of $97.3 million. On 15.2 million shares outstanding the loss per share reached $6.40.

After The Bermuda Honeymoon
In contrast to these companies, RSL Communications will enter the public market sitting on $312.2 million in debt and touting a track record of sizable losses, at least $60 million in ‘97. It will be off-shore in Bermuda and to a large extent away from the scrutiny or involvement of the stockholders.

The Company has put potential investors on notice that the proceedings should last 15 to 20 months. It will be used for more acquisitions, for capital equipment, and for working capital. After this money is spent, we can expect them back at the trough asking for more.

The underwriters will be working hard to make a market for its stock, and to that end they will do what it takes to maintain or even increase the stock’s opening position. It may even find its way into the low to mid twenties. Only later will market forces come into play, and then the burden of debt, the inability to show a positive EBITDA, and the dilutive effects of scores of millions of shares will become undeniable.