Subject: [NEXTEL-1] 17-Oct-03 Legg Mason On Nextel

From: [email-masked]
Date: Thu, 23 Oct 2003 08:46:20 -0400

17-Oct-03 Legg Mason (Mallitz, Craig) NXTL NXTL: Very Strong Quarter; Increasing
Estimates Company Note                   NASDAQ:NXTL                        Craig
Mallitz October 17, 2003                                          RATING:
B/3
Tahmin Clarke

FUNDAMENTALS                        |
|
Price (10/16/03)           $22.36 | FY End Dec      2002
2003       2004
S&P 500 Index (10/16/03)    1,050 | Revenue(MM) $8,721.0
$10,748.  $12,130.0
52-Week Range                23-9 | Prev (MM)
$10,360.  $12,185.0
Market Cap(MM)          $23,254.4 |
Shares Out(MM)            1,040.0 |
Enterprise Value(MM)     $32,891. | EPS
Avg Daily Vol(3mo)      17,993,33 | Q1          ($0.35)A
$0.20A     $0.40E
Debt/Total Cap.             36.00 | Q2          ($0.05)A
$0.27A     $0.50E
Net Cash/Share              $2.34 | Q3            $0.14A
$0.32A     $0.52E
Dividend                    $0.00 | Q4            $0.21A
$0.35E     $0.50E
Yield                        0.0% | Fiscal Year ($0.05)A
$1.14E     $1.92E
Book Value/Share            $2.96 | Previous Est.
$1.12E     $1.60E
| EV/Revenue      3.8x
3.1x       2.7x
| P/E               NM
19.6x      11.6x

* In our view, Nextel continues to generate the best results in the wireless
industry, bar-none, and yesterday the company reported results that far surpassed
our estimates and the investment community's heightened expectations.

* We are raising our target price on the shares of Nextel to $28 based on 13x our
2004 FCF estimate and just over 21x our fully taxed 2004 EPS estimate of $1.30.

* Based on the company's strong 3Q03 results we are increasing our 2003 and 2004
service revenue, EBITDA, and EPS estimates and believe the company guidance is
conservative.

* During the call management revised its guidance upward to reflect the positive
business trends exhibited in the quarter. New guidance reflects expectations of
increased EPS, free cash flow, EBITDA and net additions.

* After the close on Thursday, Nextel continued its delevering efforts and
announced it would issue a $500 million 10 year 6.875% note and retire its 9.95%
senior note and 4.75% convertible note, further improving its credit profile.

* With continued momentum in operations, coupled with a steadily improving balance
sheet and fair valuation, Nextel, in our opinion, has transformed itself from a
leveraged play to one of the most attractive earnings and free cash flow stories
in the wireless industry.

Investment Conclusion

In our view, Nextel continues to generate the best results in the wireless
industry, bar-none, and yesterday the company reported results that far surpassed
the investment community's heightened expectations.  Nextel has transformed itself
from a leveraged play to one of the most attractive earnings and free cash flow
stories in the wireless industry.  While we remain cautious regarding the
uncertainty that WLNP might introduce, we believe the catalysts are in place for
the stock to move higher including strong upside potential from nationwide Direct
Connect, solid network improvements from the introduction of the 6:1 vocoder, and
a sleeker array of devices that boast more functionality which could influence
more switchers to the company's differentiated offering. Additionally, with the
introduction of competitive push-to-talk products, we remain resolute in our
belief that the technological deficiencies will harm competitive carriers' ability
to steal Nextel's valuable subscriber base and could enhance consumer awareness of
the push-to-talk product, possibly increasing the size of the addressable market.

Even at current levels, the shares remain attractive as they trade at 17.2x
estimate 2004 P/E on a fully taxed basis, which is a slight discount to the S&P
500 of 17.8x, but in our view, a premium is warranted given that we believe Nextel
will grow its earnings at 41% versus 10% for the S&P.

Accordingly, we are maintaining our Buy on the shares and raising our target price
to $28.

Actionable Items

Estimate Changes
Based on the company's strong results we are increasing our 2003 and 2004 service
revenue, EBITDA, and EPS estimates. Additionally, we are raising our target price
to $28 to reflect the continued strength in the quarter as well as the potential
upside in 2004 as we were conservative on our 2004 estimates ahead of WLNP.
Although we are maintaining the same level of subscriber growth in 2003 and a
slight decline in 2004, we are increasing our 2003 and 2004 service revenue
estimates to $9.83 billion and $11.42 billion from $9.65 billion and $11.38
billion, respectively as a result of improvements to ARPU.
Our new ARPU estimates for 2003 and 2004 are $69.96 and $68.29 up substantially
from $68.71 and $67.90, respectively based on strong uptake from nationwide Direct
Connect and continued strength in data and voice usage. As a result of the
improvements in ARPU and lowered churn, we are increasing our 2003 and 2004 EBITDA
estimates from $4.01 billion and $4.60 billion to $4.18 and $4.78 billion,
respectively. In 2004, we have lowered our churn estimate from 2.4% to 2.0% to
reflect the record-low levels of churn in 3Q03 of 1.4% and believe that in spite
of LNP, it will be difficult for Nextel's churn to increase more than 60 basis
points. Finally, we are increasing our 2003 and 2004 EPS estimates to $1.14 and
$1.92 from $1.12 and $1.60 as a result of the flow-through from increasing
estimates coupled with a reduction in interest expense in 2003 and depreciation
expense in both 2003 and 2004.

Increasing Price Target

As result of the changes to our estimates, our DCF model arrives at $28 target
prices based on a terminal growth rate of 2% and WACC of 10.7%. We have again
trimmed our terminal growth rate from 2.5% to 2% to reflect conservatism regarding
long-term competitive solutions to Nextel's signature push-to-talk product. We
would note that even though we are raising our target price in front of number
portability, we were not aggressive in any of our assumptions regarding NXTL,
specifically, we are modeling a 60
basis point increase in churn from current levels to account for any contingency
that can arise from WLNP. Besides changes in our estimates, we believe our target
is supported by reasonable free cash flow and earnings multiple. On a free cash
flow basis our target represents 13x our 2004 FCF estimate of $2.4 billion. Based
on EPS multiples we arrive at our target using an approximate 15x multiple of our
pretax 2004 estimate of $1.92 or just over 21x our fully taxed 2004 estimate of
$1.30. This compares to an S&P 500 2004 multiple of 17.8x, but in our view, a
premium is warranted given that Nextel will grow its earnings at 41% versus 10%
for the S&P.
Not in the Press Release
The Boost Mobile JV continues to ramp dramatically, garnering 102,000 net
additions during the quarter and 245,000 customers to date. We would note that is
very impressive considering the limited launch in 2 markets.
Additionally, Nextel indicated that the product has done so well in the
youth/prepaid segment that Boost would have an expanded geographic launch in 2004,
which is similar to statements we made several months ago after we found out that
Boost had chosen an advertising agency for its nationwide launch. The company
continued to be very protective of its customers, using pervasive retention
mechanisms (customer life cycle management) to reduce churn (down 70 basis points
since introduction). We don't see much upside to Nextel's 1.4% churn number as it
is company's 6-year record low and would expect the number to trend higher as a
result of WLNP. However, the base number of 1.4% indicates likelihood of
better-than-expected financial results in 2004, as churn is likely only to
increase 50-60 basis points from that level and we had previously modeled churn in
the 2.4% area. On the metric front, lifetime revenue per subscriber (LRS) at
$5,071 is one of the highest levels ever. Bad debt is at 0.7% of service revenues
which is the lowest level in 5 years and down from 1.0% in the prior quarter and
2.7% in 1Q03.

Balance Sheet

The company continued its delevering effort this quarter, retiring $2.2 billion in
principal amount in exchange for $1.76 billion in cash and 30 million shares of
common stock valued at $584 million. The company entered into a series of
maneuvers that account for the reduction in principal, which we have outlined
below. Nextel issued $2 billion in 7.375% senior notes to facilitate a reduction
in debt service as most of the company's higher-coupon notes were trading above
par. Additionally, the company initiated a direct stock purchase plan under its
existing shelf registration, which netted proceeds of $569 million for 27 million
shares. The combination of proceeds from both securities was used to reduce or
retire various securities in the capital structure. Nextel completely eliminated
the 10.65% senior discount notes, which resulted in an outflow of $676 million.
The company reduced the 9.75% senior discount notes by $415 million, the 9.95%
senior discount notes by $294 million, and the 9.375% senior notes by $71 million.
The company also announced that during 4Q03, it intends to take down an additional
$500 million of 9.95% senior discount notes, leaving a balance of $497 million.

After the close of the market yesterday, Nextel announced that it would price $500
million of 6.875% 10-year senior notes and will use the proceeds from this
transaction to completely eliminate the remaining portion, $499 million, of the
9.95% note as well as its 4.75% convertible note which had a balance of $284
million at the end of the quarter. We have modeled the pro forma transaction to be
EPS-accretive by $0.03 in 2004. With the 9.95% note that only callable note that
was left on the balance sheet until late 2004, we believe Nextel will turn its
attention to its convertible notes that remain outstanding.
Specifically, we anticipate the 6% convertible note to be the next target of the
company as these notes can convert to equity at the owners' option at $23.84. The
other 5.25% convertible is not transferable into equity until $74.40. After the
transactions are complete, we estimate Nextel to have an estimated 2004 debt and
preferred to EBITDA ratio of 2.2x, and an ending cash balance of $1.9 billion.
Nextel continues to readjust its credit profile in an effort to attain investment
grade status and we believe that given the solid operational results and deft
balance sheet maneuvering, the company will be rewarded shortly.

Free Cash Flow
We are now estimating free cash flow of $1.1 billion for the year, up from $780
million, which consists of EBITDA -$4.18 billion, Capex - $1.76 billion, Working
Capital use - $122 million, Spectrum - $432 million for UFCF - $1.87 billion. We
then subtract net interest expense - $705 million, preferred dividends of - $57
million, which results in FCF of $1.11 billion or $1.00/share. We would point out
that embedded in the spectrum outflows is $144 million for the MMDS spectrum for
the Worldcom bankruptcy proceeding, which could result in additional FCF upside if
the transaction doesn't close this year. We have also allotted an interest
obligation of $100 million in transaction fees for a mandatory swap settlement
that matures this year.

Technology Initiatives
The company has successfully launched its nationwide DC offering during August and
is now deploying the 6:1 vocoder into the network. The company is introducing the
first two handsets to take advantage of the new vocoder, the i205 and i730, which
is to be available in the marketplace next week. This is the first phase in its
"handset a month" initiative that will
carry into 2004 and allow the company to become more competitive with the myriad
of devices that other competitors boast. These handsets offer more feature
functionality including color screens, camera phones, and GPS capabilities which
could help Nextel win the purchase decision versus a Sprint PCS which, in our
view, boasted the best lineup of handsets in the industry. After the 6:1 nitiative
is completed, we believe that given Sprint PCS's and Verizon's success with
PCS Vision and "Get it Now," respectively, Nextel will announce its roadmap of
migrating users to a higher-speed data platform, whether it be CDMA, OFDM, or
widen.

Stock Outlook

Similar to last quarter, leading up to the conference call Nextel performed very
well, up approximately 15% over the last month. We expected that the stock would
exhibit weakness on the results because of the strong price appreciation leading
into the conference call, but the quarter was strong enough that investors believe
there is further upside potential.  We believe that Nextel will lead an overall
strong quarter from the industry with particular upside from Sprint PCS and
Verizon. When those companies report, positive momentum from those stocks could
overflow to Nextel. We would like to believe that the near-term strength in
operational results coupled with beatable management guidance would push the
shares higher.  However, the enigma that is local number portability forces us to
retrench and remain conservative ahead of the event. We do believe that the
headline risk of WLNP could be worse than the actual occurrence but until we get
incremental data points from this event, we remain cautious. However, strong
uptake of Nextel's nationwide Direct Connect offering and a muted effect from
WLNP, in our view, are the catalysts that will drive the shares higher. On an
EBITDA basis, NXTL trades at a premium to the group, however we believe that
premium is deserved given the company's consistent operational results which drive
both profitability and subscriber growth in addition to management's beatable
guidance.

Operational Results

Before the open of the market yesterday, Nextel reported stellar
operational results, in our view, highlighted by strong customer
retention and solid ARPU improvement. Due to growth in gross additions, but
primarily driven by improvement in churn to 1.4%, Nextel added 663,000
subscribers, 138,00 more net additions than the consensus estimate. Based on
strong uptake of nationwide Direct Connect, improving SMS data usage and growth
in customer voice usage Nextel was able to boost ARPU to $71. Couple the
excellent churn rate with Nextel's improving ARPU and the company now boasts the
highest lifetime revenue per subscriber (LRS) of any other company in the
industry by far, at $5,071. Given the larger-than-expected average subscriber
base, ARPU bolstered EBITDA to $1.13 billion, which is up 12% sequentially
and 29% and year-over-year, and represents the second consecutive quarter of
$1 billion
in EBITDA.
Subscribers
Nextel added 663,000 subscribers, which handily beat our upwardly revised 603,000
and consensus estimates of 525,000 as the company continues to deliver a solid
value proposition and differentiated service offering to the business/high-value
consumer segment. The high-value consumer segment exhibited most of the growth in
the quarter, as we estimate that segment was responsible for generating 400,00 net
additions or 60% of the growth. The company estimates there are currently 3.8
million high-value consumers, 2.6 million government/enterprise customers, and 6.0
small business customers. We would note that while the company continues to
penetrate the high-value consumer segment, churn has attained historically low
levels, evidencing the focus on quality growth. 41% of gross additions are coming
from existing accounts, which in our view, illustrates satisfaction with Nextel's
product.

Churn

The company posted churn of 1.4%, beating our 1.6% estimate and the consensus
estimate of 1.8%. Churn declined 20 basis points sequentially and 60 basis points
year-over-year to levels not experienced by Nextel in six years. Nextel continues
to focus on its touch-point strategy with significant returns as this initiative
focuses on contact with the customer throughout every point of the transaction. We
believe that the stringent credit controls on the front end coupled with
world-class customer service and network quality continue to be the catalyst for
customer retention.  Additionally, we believe that the company is proactively
using equipment upgrades as an enticement to sign up customers for one and
two-year commitments.
Even with WLNP looming, we believe that contractual agreements with termination
fees of up to $300 will be a primary deterrent to switching carriers.

ARPU and Revenue

Nextel reported ARPU of $71, which was better than our estimate of $69.42 and the
consensus of $68.50 as customer usage continues to be a major factor driving the
solid ARPU. MOU increased 3% sequentially, coupled with a 1% increase
revenue-per-minute (RPM) to boost ARPU. Additionally, the company asserts that
increased SMS data revenues coupled with the premium priced $15 nationwide DC
offering is bolstering ARPU. We estimate that the contribution for nationwide DC
was approximately $0.50 in the quarter, which is especially impressive in light of
the deployment not occurring until roughly 1/2 of the way through the quarter.
Based on the better-than-expected subscriber growth and solid ARPU, service
revenue came in much higher than expected at $2.89 billion handily surpassing our
$2.67 billion estimate. Service revenue at these levels represent a 9% and 22%
improvement over 2Q03 and 3Q02, respectively. Couple the excellent churn rate with
Nextel's improving ARPU and the company now boasts the highest lifetime revenue
per subscriber (LRS) of anyone in the industry by far at $5,071.

Operating Expenses
Reported cash cost per user (CCPU) of $24 was up sequentially as
better- than-expected G&A expenses couldn't offset the strong rise in the
cost of service revenue expenses. The solid G&A line was driven by a
sequential reduction in bad debt expense to 0.7% of revenues, down from the
historically low level of 1%. The company continues to do an outstanding job of
credit evaluation as the balance sheet is fully reserved for accounts
that are 60 days past due. The increase in CCPU is primarily driven by cost of
service line as customer usage continues to increase coupled with more
subscribers on the network. CPGA of $450 came in lower than our $460 estimate and
was primarily driven by a substantial improvement in the equipment
subsidy. We calculate the equipment subsidy to have declined by $9 per gross
addition to $127 in the quarter. The selling expense was higher than our
estimate as the company launched its new nationwide advertising campaign in this
quarter increasing its marketing expenditures. The company's CPGA has
remained within a narrow range as it continues to focus on the high-value segment
and ahead of WLNP, we believe Nextel will continue to drive its differentiated
brand
keeping CPGA at current levels.

EBITDA

Nextel generated EBITDA of $1.13 billion, ahead of our $1.08 billion estimate and
the consensus of $1.07 billion on the strength of better-than-expected revenues.
Although cost containment wasn't as strong, the ARPU improvement more than offset
any downside from the cost structure and resulted in the second consecutive
quarter of the company generating > $1 billion in EBITDA. 3Q03 EBITDA represents a
43.4% margin on service revenue, a 230 basis point sequential improvement, as the
company has boasted six consecutive quarters of 40%+ EBITDA margins. EBITDA at
this level represents growth of 12% and 29% over 2Q03 and 3Q02, respectively.

Capital Expenditures

Capital expenditures of $403 million was lower than our $525 million estimate as
the company continues to assert that it will spend $1.8 billion or less in 2004.
Capex so far this year is around $1.3 billion and we will be surprised if the
company doesn't hit its capital expenditure guidance to improve network quality
ahead of WLNP. Mr. Donahue has recently stated that Nextel is focused on
increasing its coverage and we believe that is partially built in to the $575
million in investment left unspent.  Management noted that it is currently
implementing the 6:1 vocoder and we believe that the company has already started
the process of seeding its base as some phones sold during 3Q03 had the software
to work with the vocoder.  Additionally, we believe that Nextel's new line of
handsets (2 due to be introduced next week) will have the 6:1 technology embedded,
which will boost capacity.

Management Guidance

During the call management revised its guidance upward to reflect the positive
business trends exhibited in the quarter. The company is now expecting free cash
flow of $1 billion or more up from $600 million. The company is forecasting EPS of
$1.15 or more and EBITDA of $4.1 billion, up from $1.00 and $3.9 billion,
respectively. Finally, given the subscriber strength, the company expects to add
2.2 million or more customers up from 1.9 million, with capex guidance remaining
unchanged.

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