Subject: [NEXTEL-1] Bear Stearns Report On Nxtl Q3-03

From: [email-masked]
Date: Fri, 17 Oct 2003 16:59:09 -0400

17-Oct-03 Bear Stearns US (Cusick,Phil NXTL AWE
NXTL: DONE
Phil Cusick                      10/17/03
Avi Silver 

Data
Target Price-Yr.End '04 $25

Key Points
*** STRONG QUARTER BY ANY MEASURE. Nextel reported an excellent 
quarter, with net adds, gross adds, churn, ARPU, & EBITDA all better than our
estimates.

*** BALANCE SHEET IMPROVEMENTS CONTINUE. The company bought back 
more debt than we had been expecting using cash and stock, and also raised 
$500 million in equity through a direct stock purchase plan.

*** INVESTMENT THESIS INTACT. While much of the quarter's strong 
results had been anticipated by investors, we believe that NXTL will 
continue to outperform its peers.  Management continues to deliver, and we 
see the consistent fundamental outperformance and strong earnings/FCF 
visibility as critical to our investment thesis heading into number portability.

*** ESTIMATES UNDER REVIEW.   We are placing our 4Q03 and 2004 
estimates under review pending a meeting with management on Friday.

SUMMARY OF RESULTS
Results Strong Across the Board Nextel reported another stellar quarter, with net
adds, gross adds, 
churn, ARPU, & EBITDA all better than our estimates.  EPS was in line with 
our estimates, only because of higher than estimated premiums used to 
take out the high coupon notes.  Despite the higher number of gross additions, 
EBITDA still beat our estimate by 5%, and margins were 50 basis points better 
than our forecasts Subscribers. Gross adds came in at 1.150 million, 5% better
than our estimate of 1.093 million and reflecting a robust environment for
subscriber growth.

Churn of 1.4% was also better than our 1.6% estimate.  We estimate that the
company upgraded 6% of its customers, which is 100-150 b.p. above the company's
typical upgrade rate.  If these customers would not have upgraded and would have
left for another carrier, churn would have been closer to our 1.6% estimate.  We
view the incremental upgrades as positive in that retaining a customer is far
cheaper than getting a new one, but note that the reduction in churn does come at
a price.  The better than expected gross adds and churn resulted in net adds of
646k, better than our official 520k estimate and in the range many investors were
looking for following bullish presentations by management.

ARPU/Revenue. ARPU was the biggest surprise to us, coming in at $71, 3% ahead of
our $69 estimate.  The biggest factor in driving ARPU was increased overage,
something some other national operators are seeing move in the other direction.

Increased regulatory fees have contributed to ARPU stability year-year, which are
likely not repeatable going forward.  In addition, we believe that national Direct
Connect usage is starting to affect ARPU, though it is still likely below $1
contribution.

On the overage, the company's average customer minutes of use growth accelerated
faster than it had in the previous five quarters.  Average monthly minutes of use
increased to 740, growing at 14% on a y-y basis, the highest y-y MOU growth rate
we have seen since 1Q02.  Further, Nextel has kept its pricing stable despite
increases in MOU's from most other operators.  In fact, Nextel's core free
incoming and national shared minutes plans have not changed at all since February
of this year.  Thus, the company has seen little re-rating of customers migrating
to lower price points.  It is also important to consider that NXTL also has
virtually no low-end plans: no prepaid and no postpaid plans below the $30 level. 
This mitigates the risk of the company driving its adds through low-end consumers
with low MRC, which we think are an issue in the industry this year.

EBITDA. Despite the higher number of gross additions, EBITDA still beat our
estimate by 5%, and margins of 43.4% were 50 basis points better than our
forecast.  We believe EBITDA outperformance was driven by a combination of higher
ARPU, lower CPGA ($450 vs. $470 estimate) and lower churn/bad debt expense.  This
was somewhat offset by increased retention costs, which we estimate were $80
million this quarter.
3Q03 Earnings Comparison

3Q03   3Q02  % Change  3Q03E % 

Variance
Net subscriber additions              646    480      35%    
520       24%
Gross additions                     1,150  1,073      7%   
1,093       5%
Total churn                          1.4%   2.0%            1.6%
ARPU                                  $71    $71      0%     
$69       3%
Service revenue                     2,599  2,139      22%  
2,496       4%
EBITDA                              1,129    878      29%  
1,071       5%
EBITDA margin of service revenue    43.4%  41.0%           42.9%
EPS                                 $0.32                  
$0.32       -1%
Capital expenditures                  403    401      0%     
540       -25%
Source: Bear, Stearns & Co., Inc. estimates.

Boost Mobile. Though only operating in California and Nevada, Boost mobile
registered 102,000 net adds during the quarter, a 73% growth rate over the
June-end 140,000 customers.  The company indicated that the Boost churn was lower
than that of the overall industry prepaid level, which we estimate to be
approximately 8% based on the BCGI (which operates the Boost prepaid billing
system) announcement Wednesday.  With churn and ARPU better than the prepaid
average, we expect Nextel to roll out the Boost product in about six more markets
beginning late in 1Q04.  We find it very interesting that Boost was able to
generate that much demand in just two states, and think it is a sign of how
attractive Nextel's product is to customers.

QUALITY OF SUBSCRIBERS

"Individuals " Drive Growth, But Not Causing Rise in Churn, ARPU Nextel has
classified its customer base into three groups, including government/enterprise,
small/medium sized businesses, and all other falling into an individual category,
widely perceived as consumer.  While the segments are blurred because the fastest
growing individual segment's business customers cannot be measured, we describe
each group's contribution to net and cumulative subscribers below.

Government and Enterprise segments: 2.6 million customers today and defined as a
customer signed up under a corporate or government contract and which has 3 or
more handsets on that contract.
Small and medium-sized customers: 6.0 million customers who also have multiple
units under the same account, and may or may not have a business-type contract.

Individuals are the plug: 3.8 million customers today which are one or two
handsets under the same account and are not on a business or government contract.
These customers may, however, reference a business or government contract that
they are associated with, but for whatever reason are not part of that account
(often having to do with who is liable for the charges).

It is important to note that there are actually few differences between many
individual customers and a corporate customer.  For example, many - or perhaps
even a majority - of the company's  "individual " customers are often business
users coming through the consumer channel and who may be expensing the handset and
service to an employer, or are merely small business users that are under the
radar screen of the business sales department at Nextel.  This is perhaps
evidenced by the company's pricing structure, which relative to other carriers, is
not very attractive to most typical consumers.  Further, the higher ARPU lower
churn consumer is not showing up in the #'s with ARPU significantly outperforming
estimates and churn at historically low levels.

Nextel is not alone in having problems classifying its customers; in our 4Q02
study Corporate Spending: Talking to the Heavy Users we found that the other
wireless carriers had little knowledge as to which of their customers were using a
phone for business or for personal matters.

Attributing Growth

Nonetheless, it is still interesting to look at some of the comparisons, which
suggest continued rapid growth in the consumer segment.  The table below
highlights the percentage of the base and percentage of growth (net additions),
which implies that the individual segment is the fastest grower at the company.

Individuals continue to comprise the largest portion of the growth, but the
government and enterprise appeared to have a good quarter, representing 29% of the
net add growth in 3Q03, up from the prior two quarters.  Note that reported
numbers are subject to significant rounding error.

Nextel Customer Breakdown

Cumulative Subscribers 1Q03 2Q03 3Q03   % of Subscribers   1Q03  
2Q03  3Q03
Government              2.3  2.4  2.6           Government 20.7% 
20.5% 21.0%
Individual              3.0  3.4  3.8           Individual 27.0% 
29.1% 30.6%
Business                5.8  5.9  6.0             Business 52.3% 
50.4% 48.4%
Net Additions     1Q03 2Q03 3Q03  % of Net Additions  1Q03  
2Q03  3Q03
Government              0.1  0.1  0.2           Government 20.0% 16.7% 28.6%
Individual              0.3  0.4  0.4           Individual 60.0% 66.7% 57.1%
Business                0.1  0.1  0.1             Business 20.0% 16.7% 14.3% Note
that customer percentages are based on rounded numbers.

Source: Bear Stearns & Co. Estimates

BALANCE SHEET

In addition to the previously announced buybacks during the quarter, the company
issued 30 million shares to take out an additional $584 million in debt, and 27
million through its direct share purchase program (the maximum allowable under the
recently issued $5 billion shelf).  The company guided that net debt will be
reduced to an aggressive $9 billion by year-end, better than our original $9.9
billion estimate, but in-line when considering the equity issuance above.  Despite
some share dilution, we view the continued balance sheet improvements as critical
to NXTL and its focus on upgrades by credit ratings agencies.

Separately, NXTL issued $500 million in new notes on Thursday with an 6.625%
coupon.  We view this positively for a non-investment grade company to offer notes
at a near-investment grade coupon.  Note that investment grade AT&T Wireless'
currently trades at an equivalent yield.

On the accounts receivable, we had received some questions regarding the
sequential increase of accounts receivable in the context of a decline in bad debt
expense.  A/R rose 5% and by $55 million while bad debt expense fell by $6 million
from 2Q.  However, revenue grew sequentially at 9%, leaving DSO's at 43 days,
which is nearly 2 days less than in the previous quarter.  The trend for DSO's has
been quite favorable over the past few quarters, which we view as positive.

Accounts Receivable and Bad Debt (Dollars in millions)
                                1Q02  2Q02  3Q02  4Q02  2002  1Q03  
2Q03  3Q03
Bad debt expense                   94    80    87    75   335    
57    26    20
% of revenue                     4.8%  3.7%  3.8%  3.2%  3.8%  2.4%  
1.0%  0.7%
A/R less allowance for doubtful accounts  963 1,153 1,303 1,077 
1,077   996
1,162 1,217
Average collection period (DSO) 48.0  51.8  55.6  45.0  48.0  41.1  
44.5  42.7

Source: Bear Stearns & Co. Estimates

SAB 101. In accordance with SAB 101, Nextel this quarter began expensing the
revenue and costs associated with handset sales instead of amortizing them over
3.5 years. This resulted in higher equipment cost and revenues, and a $1.3 billion
write-down of associated assets and liabilities. The income statement effect was
minimal. We had been expecting this, and details can be found further down in this
note.
SAB 101 / EITF 0021 Update

As expected, Nextel this quarter  stopped deferring offsetting amounts of handset
revenue and expense, bringing itself primarily in-line with the rest of the
industry's accounting practices.  In addition, the company decided to write down
its ~$1.3 billion balance sheet asset and liability related to this accounting
method.  There was no EPS effect as, again, the amounts are offsetting, but we
wanted to reprint an explanation from previous notes below.

The following section was originally printed in our May 2003 initiation.

Background

Under Accounting Standards Board (SAB) No. 101, Nextel is required to amortize
offsetting amounts of handset cost and revenue over the 3.5-year life of its
average customers.  The amount of handset cost over and above the amount of
handset revenue (the handset subsidy) is expensed during the quarter in which it
occurs.  Thus, the handset revenue that the company actually reports every quarter
is comprised of only one-fourteenth of the actual quarter's handset revenue plus
the amortized amount from the previous 13 quarters.  An offsetting amount of
handset cost is also amortized each quarter in addition to the total amount of
handset subsidy ( yielding zero impact on EBITDA or cash flow.
In times of stable handset sales, costs, and revenues, this wouldn't matter, but
in a year when handset sales grew and the company drastically lowered its handset
subsidy, the cost and revenue lines would appear much smaller than they actually
were.  This was the case in 2002, when Nextel grew handset sales by approximately
30% and also changed its dealer policies to lower the subsidy on handsets.  When
we normalize the numbers by grossing up the equipment revenue and cost lines, we
find that this accounting treatment provided Nextel with an additional 150-bp
contribution to the EBITDA margin in 2002 when calculating the margin using total
revenues.

Why Investors Should Care

While this is strictly an accounting issue and does not affect absolute EBITDA or
cash flow at all, we believe that Nextel shareholders should be aware of the issue
for two reasons.  First, and to the company's credit, Nextel management almost
exclusively talks about EBITDA margins in terms of service revenue, which is not
affected by this accounting treatment.  Yet many investors and research analysts
refer to EBITDA margin as the percentage of total revenue, not service revenue. 
Looking at it this way gives Nextel an advantage over other carriers that are not
required to follow SAB 101 on this issue.

This obviously begs a question of why aren't other carriers required to follow SAB
101, and the answer lies +with technology.  Because Nextel is the only carrier
that uses iDEN phones, the SEC argues that a Nextel phone has a life that is tied
to that of the customer and so has a definite period over which to be amortized.

  Other carriers have more common technologies and run the risk that their phones
could be reprogrammed to run on another carrier.  Thus, because a Sprint phone
could be turned into a Verizon Wireless phone, the other carriers cannot provide a
definite life and do not follow SAB 101.  Complicated, but that's accounting!

The second problem is that when handset sales begin to slow (which we expect will
happen in 2005 or 2006 after Nextel upgrades a huge number of handsets in 2005 to
meet E911 requirements), the company will have what is a benefit today become a
margin drag as amortization from past periods will be associated with a smaller
number of gross additions, making its quarterly equipment cost and revenue lines
look far bigger than they are.  Nextel would then have a disadvantage on an
EBITDA-over-total revenue comparison that would have to be recognized.

Possible Reversal with EITF 00-21?

In November 2002, the Emerging Issues Task Force (EITF) released guidelines for
accounting for  "multiple deliverables " in regards to revenue recognition.

EITF 00-21 provides clarification for occasions when  "delivered items should be
considered a separate unit of accounting, " such as when a wireless carrier sells
a phone and later provides service to go with that phone.  If any of the
deliverables should be accounted for separately, EITF 00-21 requires that total
arrangement consideration be allocated to the separate deliverables based on
relative fair value.  EITF 00-21 does not provide guidance on the appropriate
revenue recognition method for a separate deliverable.  Revenue for a separate
deliverable should be recognized when the earnings process for that deliverable is
completed based on the revenue recognition appropriate for it as established by
other GAAP such as SAB 101.  Section 9A of EITF 00-21 reads that delivered items
should be considered separate units of accounting when, among other things:
"The delivered item(s) has value to the customer on a standalone basis. That
item(s) has value on a standalone basis if it is sold separately by any vendor or
the customer could resell the delivered item(s) on a standalone basis.  In the
context of a customer's ability to resell the delivered item(s), the Task Force
observed that this criterion does not require the existence of an observable
market for that deliverable(s). "
The last sentence (italics) is the important one for Nextel, as the lack of a
demonstrable market for iDEN phones has been the reason historically that Nextel
accounted for the sale and costs of its phones as one unit of accounting under SAB
101 in contrast to that of its peers.  The company argues in its 2002 10K in
discussing EITF 00-21 that  "we no longer need to consider whether a customer is
able to realize utility from the handset in the absence of the undelivered
service. "  Were the company to adopt EITF 00-21, it would start recognizing the
complete revenue and expense of a handset upon activation, rather than amortizing
the offsetting cost and revenue over three and a half to four years.

Nextel has not yet decided whether it will change its accounting for handset
revenue and cost recognition.  Under this EITF, Nextel has the option of moving to
the new format only for transactions entered into in fiscal periods beginning
after June 15, or truing-up its financial statements to account for all historical
transactions as well through a  "cumulative effect of an accounting change. "

Were Nextel to decide to change its historical treatment for the new methods, it
would likely write down the offsetting handset revenue and expense numbers on its
asset and liabilities lines.  While this would have no cash flow or EBITDA impact,
it would lower the assets and liabilities of the company by approximately the $1.2
billion that was on the balance sheet at the end of March 2003 and is accounted
for in the  "other assets " and  "deferred revenues " lines.

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