Subject: [NEXTEL-1] JP Morgan On Nxtl Q3-03

From: [email-masked]
Date: Fri, 17 Oct 2003 17:22:12 -0400

17-Oct-03 J.P. Morgan (Thomas J. Lee, CFA  AWE NXTL Nextel : 3Q03 Shows Good
Execution.  Raising '04 Estimates.
                      Neutral
Ticker          NXTL        EPS            2002A  2003E (Old) 2003E (New)
2004E
Price(10/16/03) $22.36      1Q (Mar)      ($0.81)    $0.20A      
$0.20A     NA
52-Wk.Range     $7.84-22.23 2Q (Jun)       $0.35     $0.27A      
$0.27A     NA
Mkt.Cap(BN)     $24.01      3Q (Sep)       $0.53     $0.28       
$0.32A     NA
Fiscal Year     Dec         4Q (Dec)       $0.27     $0.22       
$0.40      NA
Shares O/S(MM)  1,074.00    FY             $0.34     $1.00       
$1.19    $1.66
Sales FY (BN)                              $8.19     $9.54       
$9.85   $11.41

* Nextel reported solid 3Q results yesterday on all key metrics, including net
adds of 646k (vs our 550k), service ARPU at $71 (vs our $68), and 
EBITDA of $1.1 billion (vs our $1.0b). The company's performance is better 
than our (and investor) expectations.

* ARPU and lower churn driving the upside in our EBITDA and net income estimates
for the quarter. One open item, however, is that lower churn was achieved in part
through higher retention spending as opposed to higher gross adds. In addition,
ARPU was driven by high national DC usage. The question going forward is will this
level of usage continue and whether PTT competition will drive lower ARPU.

* We are raising our 2004 estimates with EPS now forecast at $1.66 
(vs $1.49 previously), boosting our churn outlook (2.0% for FY04 vs our prior
2.5%) and ARPU ($67 for 2004E vs our prior $66). Our model will be sensitive to
the changes here with a 20bp deviance in churn or a $1 swing in ARPU representing
$0.14 change to our EPS estimate.

* Industry implications. Nextel's result have positive implications for the
wireless industry as we did not get the sense they came at the expense of other
carriers. In fact, the company achieved these results via lower churn and
retention while boosting revenues from its customer base. This suggests industry
demand is ahead of our forecast - that is, industry net adds are about 100k ahead
of expectations so far.

* Net-net: We reiterate our Neutral rating on the stock despite increasing
earnings estimates for company. NXTL's current stock price implies  FCF growth of
6% (after 2004), while a similar analysis for AT&T Wireless (Overweight-AWE) and
Sprint PCS (Neutral-PCS) imply 2.3%-2.9%. Therefore, we see relatively more
attractive valuations in AWE.

Portfolio Manager's Summary

Nextel reported solid 3Q results yesterday, delivering a quarter that demonstrated
strong progress on all key metrics?net adds of 646k (vs our 550k), service ARPU at
$71 (vs our $68), and EBITDA of $1.1 billion (vs our $1.0b).

The company's performance is better than our (and investor) expectations, and we
are consequently raising our 2004 estimates with EBITDA now of $4.7b (vs $4.4b
previously) and EPS of $1.66 (vs previous $1.49).A key item to note, however, is
that the driver for estimate risk to our model is churn rate and ARPU?in other
words, these drove the upside in reported results and are key to our raised
estimates.

Solid execution on 3Q with lower churn and higher ARPU as drivers.3Q results were
impressive with better ARPU and lower churn driving the upside in our EBITDA and
net income estimates.Nextel's customer base is clearly less inclined to churn
while their national Direct Connect product seems to have boosted ARPU.

* One of the open items, however, is that the lower churn appears to be achieved
in part through higher retention spending.As shown on Table 1 below, the
company's?non-customer acquisition marketing cost?has been steadily
increasing.Gross adds still show some sequential progress, but have remained about
1.1mm per quarter, with the rise in net adds due to lower churn.

* In addition, 30% of its base used the national DC feature during the quarter,
boosting ARPU.The question going forward is whether there was any accidental DC in
the 30% figure (do customers PTT not realizing that the other party was out of
region) and whether PTT competition will drive lower ARPU.
* Still, we find little to question in the overall quarter and view the sharp rise
in EBITDA margins (to 43%) and net income normalized (18% margins) as a further
example of the profitability of the wireless business model.

2004 estimates raised.We are raising our 2004 estimates with EPS now forecast at
$1.66 (vs $1.49 previously).We describe our estimate changes later in this note
but the key takeaway is we are boosting our churn outlook (2.0% for FY04 vs our
prior 2.5%) and ARPU ($67 for 2004E vs our prior $66).As highlighted in this note,
our model will be sensitive to the changes here with a 20bp deviance in churn or a
$1 swing in ARPU representing $0.14 change to our EPS estimate.Therefore, one key
assumption is what impact we may (or may not) see in 2004 from competitive PTT
products.

Industry implications.Nextel's result do have positive implications for the
wireless industry as we did not get the sense NXTL's strong results came at the
expense of another carrier.In fact, the company achieved these results via lower
churn and retention while boosting revenues from its customer base.This obviously
does speak positively of the importance and value of Direct Connect, but it also
suggests the industry demand picture is ahead of our forecast?that is, industry
net adds are about 100k ahead of expectations so far.

Net-net:Our increases to our 2004 estimates is most apparent in our boost to EPS
guidance.Peering into 2004, investors are likely to focus less on EBITDA metrics
and value wireless equities increasingly on a P/E or P/FCF basis.

Looking at wireless valuations, Nextel current stock price implies FCF growth of
6% (after 2004) (which as we have written previously solves arithmetically to
equity cost of capital less FCF yield), while a similar analysis for AT&T Wireless
(Overweight-AWE) and Sprint PCS (Neutral-PCS) imply 2.3%-2.9%.
Therefore, we see relatively more attractive valuations in AWE.

Further Discussion of Nextel`s 3Q03 Results

As discussed above, Nextel reported solid 3Q results last night, delivering a
quarter that demonstrated strong progress on all key metrics.As discussed in
greater detail in Table 7 at the end of this note, in the quarter Nextel had net
adds of 646k (vs our 550k), churn of 1.4% (vs our 1.8%), service ARPU of $71 (vs
our $68), and EBITDA of $1.1 billion (vs our $1.0b).A key item to note, however,
is that the drivers of outperformance in the quarter were lower than expected
churn and higher than expected ARPU.

One of the reasons for the improvement in churn is likely an increase in retention
spending, which is included in customer acquisition?costs unrelated to initial
customer acquisitions.?This line item was $89mm in 3Q03, which was up from $68mm
in 2Q03 and $60mm in 1Q03.We cannot simply calculate retention costs from this
figure, however, because it includes customer acquisition costs from Boost Mobile,
which we isolate in Table 2 below.After subtracting the $23.9mm we attribute to
Boost Mobile, we see that retention in the quarter was $65.1mm, an increase of
$15.0mm from $50.1mm in 2Q03 (see Table 1).

The key question is whether this increase in retention spending is leading to a
productive reduction in churn.As demonstrated in Table 1, retention spending was
up $15mm in 3Q03 from 2Q03, while the improvement in churn was 42,000.We calculate
that this increase in retention equals $353 for each reduced disconnect (retained
subscriber).We believe it is important to isolate this number because retention
spending could increase due to the launch of competitive PTT offerings and
pressure from WNP, leading to an increase in the percentage of the base upgrading
their handsets, which was 6% in the quarter, vs 4-5% historically.

Table 1: Implied Cost of One Less Disconnect
                                                          1Q03     
2Q03    3Q03
Retention spending                           ($ mils)    $46.8    
$50.1   $65.1
Period disconnects                             (000s)      619      
547     504
Seq. chg retention                           ($ mils)              
$3.3   $15.0
Seq. chg disconnects                           (000s)              
(72)    (42)
Calc cost of one less disconnect       ($/disconnect)               
$46    $353

Source: Company reports and JPMorgan estimates.

Boost Mobile Acquisition Costs.

Nextel's youth market effort is based on a retail product called Boost Mobile,
which is consolidated in Nextel's earning statement.However, because Boost
Mobile's subs are not included in total subs, it is important to estimate this
number and it's impacts on CPGA calculations.As demonstrated in the following
table, assuming churn of 3.0% and a CPGA of $200 results in a $23.9 marketing cost
related to Boost Mobile in 3Q03.

Table 2: Boost Mobile Estimates
                            1Q03      2Q03     3Q03    4Q03E    
2003E     2004E
Gross Adds                    66        89      119      127      
401       596
Net Adds                      63        80      102      100      
345       400
Ending Subscribers            63       143      245      345      
345       745
Service Revenues            $4.3     $13.9    $26.2    $39.8    
$84.2    $294.3
CPGA                        $200      $200     $200     $200     
$200      $200
Acquisition Costs          $13.2     $17.9    $23.9    $25.3    
$80.2    $119.2

Source: Company reports and JPMorgan estimates.

CCPU Increases

One other incremental trend we noticed was an increase in Nextel's cash cost per
user (CCPU), which increased 3.0% to $23.90 in 3Q03 from $23.21 in 2Q03.

The company noted the increase was due to (1) increased employee costs (higher
number of employees at an increased number of stores and also in call centers),
(2) increases in attorney and regulatory fees due to recent litigation in Missouri
and other items, and (3) continued upgrading of the company's back office
systems.3Q03 is the second consecutive quarter of increasing CCPU, reversing the
trend of seven consecutive quarters of decreases through 1Q03. Rising CCPU is not
an issue because Nextel's ARPU has been increasing.
Table 3: Cash Cost Per User Has Increased In The Last Two Quarters
                           2Q02      3Q02      4Q02      1Q03     
2Q03     3Q03
Cash Cost Per User       $26.20    $25.45    $24.19    $22.85   
$23.21   $23.90
% change q-o-q            -2.7%     -2.9%     -5.0%     -5.5%     
1.6%     3.0%

Source: Company reports and JPMorgan calculations.

Change To Estimates

We making changes to our 2004 estimates on the heels of a better trend in ARPU and
churn.The two major changes are we are now looking for 2004 churn of 2.0% (vs 2.5%
previously) and ARPU of $67.37 (vs $65.88 previously).As demonstrated on the
following table, these changes drive increases in our other estimates.
As you may be aware, we have been increasingly cautious about the industry
structure for wireless given WNP.For NXTL more specifically, there is likely to be
heightened competition for NXTL's core base of users as other carriers roll out
competitive PTT products.Investors may not be aware that there can be large
changes to earnings with relatively small changes to two core metrics, churn and
ARPU, that may be effected by competition.This sensitivity is illustrated in
Tables 5 and 6 below.
Table 4: JPM Estimate Changes and Guidance

(Net adds in 000s, $ in millions except ARPU and per share amounts)
                             2003                              2004
                            Prior        JPM      Guid.       
Prior         JPM
Net Adds                    2,046      2,242      2,200       
1,500       1,700
Churn                        1.9%       1.6%                   
2.5%        2.0%
ARPU                       $67.43     $68.97                 
$65.88      $67.37
Service Revenues           $9,579     $9,850                
$10,759     $11,413
EBITDA                     $3,976     $4,174     $4,100      
$4,419      $4,683
Capex                      $1,800     $1,800     $1,800      
$1,800      $1,800
EPS                         $1.00      $1.19      $1.15       
$1.49       $1.66
FCF / Share                 $0.30      $0.51                  
$1.41       $1.58

Source: Company reports and JPMorgan estimates.

Sensitivity to Changes In The Churn Rate

We have illustrated the sensitivity to EPS from a 20bps change in churn.Each 20
bps change results in approximately 329k more gross adds required, and using a
CPGA of $452 implies EBITDA would be reduced by $148.7mm?  assuming the company
would try to retain net adds in the face of higher churn.This calculates to $0.14
per share.

Table 5: Sensitivity to 20bps Change in Churn Rate
     2004E
Baseline churn rate                                       
(%/mth)          2.0%
Disconnects baseline                                       
(000s)         3,299
Incremental churn on +20bp churn rate                      
(000s)           329
CPGA (ex-retention)                                 ($/gross 
add)          $452
Total incremental marketing costs                        ($ 
mils)        $148.7
Shares outstanding                                         
(mils)         1,091
2004E EPS                                               
($/share)         $1.63
Change to 2004E 
EPS                                                     ($0.14)
% impact to 2004E 
EPS                                                       -8% Source: Company
reports and JPMorgan estimates.

Sensitivity to Changes in ARPU

Nextel's average ARPU is $15-17 above the industry average, reflecting an
associated premium with its direct connect product.Over time we expect competitors
to offer lower priced PTT services (priced lower probably to reflect lower
performance vs NXTL), and therefore we wanted to highlight the sensitivity of
earnings to ARPU changes.As shown on the table below, a $1 decrease in ARPU leads
to a decrease in EPS of $0.15, or 9%.
Table 6: Sensitivity to $1 Change in ARPU 2004E

Baseline ARPU                                        
($/mth/sub)         $67.37
Avg subs                                                  
(000s)         13,704
Change in revenues on $1 ARPU change                    ($ 
mils)         $164.4
Shares outstanding                                        
(mils)          1,091
2004E EPS                                              
($/share)          $1.63
Change to 2004E 
EPS                                                     ($0.15)
% impact to 2004E 
EPS                                                       -9% Source: Company
reports and JPMorgan estimates.

6-to-1 Vocoder Update

Nextel stated that it has received network software for its new 6-to-1 vocoder and
has been testing it in selected markets.NXTL expects to start selling handsets
containing the vocoder within the next couple of weeks and will upgrade its
network on a market by market basis.The technology is both forward and backward
compatible, meaning that existing handsets will work on upgraded network and the
new handsets will work on the old network.The vocoder is important to NXTL as it
will double the company's voice capacity on its existing network and spectrum.In
anticipation of expected capacity increases, NXTL has reduced its capacity capex
spending, using low cost methods to increase the capacity of existing cell sites
where possible instead of increasing the number of total sites (splitting cells).

As for timing, NXTL had originally intended this product to be deployed in its
network and to be selling the handsets in 3Q03.One of the open questions is
whether a delay of the network deployment and seeding of the base with the 6-to-1
handsets will necessitate higher capex next year.Regarding capex this year, NXTL
is likely to incur software deployment costs in 4Q03, and therefore could end up
spending the full $1.8bn in 2003.

Wireline to Wireless Portability

The company stated on its earning call that it continues to lobby the FCC to
implement wireline to wireless portability, which it believes will be beneficial
to both customers and the wireless industry.The company believes that the primary
benefit to Nextel and the wireless industry of wireline to wireless portability
would be greater ARPU and usage, while subscribers growth would be a secondary
benefit.In addition, Nextel believes the opportunity lies in both retail and
business customers.One initiative the company is exploring is to port wireline
numbers to the second line of existing Nextel subscriber's handsets.All Nextel
phones are currently designed to accept a second lines.

Figure 7: Nextel Third Quarter Highlights (subs in 000s, $ in millions except
ARPU)
                                       3Q02        2Q03       
3Q03E        3Q03
Net internal adds                       480         591         
550         646
Subs, ending                         10,116      11,683      
12,233      12,329
Launched penetration gain             0.23%       0.29%       
0.27%       0.31%
Launched Penetration                  4.93%       5.65%       
5.91%       5.95%
Customer churn / month                2.00%       1.60%       
1.80%       1.40%
Avg monthly revenue                  $72.20      $69.81      
$69.10      $72.16
% chg?y-t-y                            1.7%       -3.1%       -
4.3%       -0.1%
Total Service Revenues               $2,139      $2,385      
$2,479      $2,599
% chg?y-t-y                           26.7%       17.4%       
15.9%       21.5%
Pre-SAC/sub/month                    $25.45      $23.21      
$22.66      $23.90
Pre-mkt cash flow                    $1,385      $1,592      
$1,666      $1,738
Pre-mkt CFLO margins                  64.7%       66.8%       
67.2%       66.9%
% chg?y-t-y                           38.2%       23.1%       
20.3%       25.5%
Operating Cash Flow                    $878      $1,004      
$1,038      $1,129
OCF margins -- svc revs               41.0%       42.1%       
41.9%       43.4%
% chg?y-t-y                           66.9%       23.0%       
18.2%       28.6%
Net Income (Loss) (MM)                 $526        $281        
$346        $346
EPS (loss)                            $0.53       $0.27       
$0.34       $0.32
Capex (in 000's)                       $412        $411        
$450        $403

Source: Company reports and JPMorgan estimates.
Valuation and Rating Analysis
At 7.2 times 2004E EBITDA, Nextel trades at the high end of 
valuations relative to other national wireless carriers (AWE trades at 5.1 
times and PCS trades at 5.4 times).We reiterate our Neutral rating based on 

Nextel's high relative valuation and the potential impact competitive push to talk 
products may have on future results.
Risks to Our Rating Downside risks to our Neutral rating are a) deterioration of
ARPU 
and churn levels due to the company's continued expansion into the consumer 
segment,

 b) the level of success and timeliness of competitive push to talk 
products, and

c) that general wireless industry risks could cause deterioration in 
overall wireless valuations such as lack of consolidation, wireless number
portability, and lack of pricing discipline. Upside risks to our 
Neutral rating are further margin expansion above its industry high 43%, 
continued strong subscriber growth through better penetration of the small and 
medium business markets and consumer markets.

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