Subject: [NEXTEL-1] 20-Oct-03 Bear Stearns US On Nextel

From: [email-masked]
Date: Mon, 20 Oct 2003 18:38:41 -0400

20-Oct-03 Bear Stearns US (Cusick,Phil ) NXTL AWE
NXTL: Highlights From Management Meeting  Raising Estimates
Phil Cusick                   10/20/03
Avi Silver Data
Target Price-Yr.End '04 $25

Key Points

*** We hosted an investor meeting with Nextel CEO Tim Donahue on Friday.  Key take-aways highlighted within include the subjects of Capex, wireless number portability, Boost Mobile, industry pricing, and Nextel's spectrum swap consensus plan.
*** We would categorize the meeting as very upbeat, with investors clearly impressed with the company's execution and strong business momentum. We continue to see Nextel as the best positioned wireless company headed into wireless number portability, and are more confident that it can take share from rivals. Nextel remains our top pick in the wireless sector.  *** We are raising our estimates for Nextel in both the fourth quarter of 2003 and 2004.  Higher ARPU and lower interest expense fuel higher EPS, but increased Capex offset the cash flow benefits.  We are raising our estimate for the company's 2004 Capex from $1.4 to $1.6 billion which we do not see as a negative.
*** Our EPS estimate for 2003 is now $1.15 from $1.10, and our 2004 number comes up to $1.72 from $1.60.  Our free cash flow estimate for 2004 rises from $1.95 billion to $2.15 billion, or $1.83 per share.  The per-share FCF in 2004 is down slightly due to higher Capex and the ~5% equity dilution that the company did in the third quarter.  *** We continue to see our model as conservative on ARPU, churn, and net additions in 2004. Net additions are based on our 12 mm 2004 industry estimate, and we may re-assess after the quarter.  We offer in this note three sensitivity analyses of our model around churn, ARPU, and EBITDA margin.

We hosted an investor meeting on Friday with Nextel CEO Tim Donahue and Paul Blalock of investor relations.  Everything from consolidation to cash flow was discussed, and we include a few of the key take-aways below.  We would categorize the meeting as very upbeat, and came away with the sense that momentum continued into the fourth quarter and that management is highly focused headed into number portability.
Capital Expenditures: Capex was the topic of the day, and we got the distinct impression that it would be closer to 2003 levels than most people expect.
Though guidance has recently been  "a few hundred million " below this year, Donahue indicated that the range was more like $1.5 to $1.8 billion, with the caveat that the numbers have not been decided yet. He did say also that he would "spend what it takes " to build a great network.
We believe that increased capital spending is totally justified given the faster ramp in subscribers and EBITDA, and the stellar cash flow that the company is demonstrating. We are raising our estimate for Capex from $1.4 (which we had originally seen as conservative!) to $1.6 billion today to account for the increased spending.  Higher Capex is primarily for more cell sites (16,800 today, with another 500 in progress and 1500 guided for 2004, approximately 5000 sites are planned over the next three years), and the company sees increased coverage as the main thing standing between it and Verizon on competition.  New sites will be primarily focused on adding corridors rather than a lot more pops, and Donahue said that he estimated it would cost $25-30 million to  "bulletproof " the network in areas of NASCAR tracks to get the most out of the advertising deal.
Other spending was a network software upgrade to W-iDEN which the company expects to allow it to reach data speeds of 60 kbps, comparable to CDMA 1X-RTT.
Wireless Number Portability: Donahue was extremely bullish on emerging as a net winner from number portability, and given the company's 1.4% churn rate this quarter we have to agree that Nextel will be a winner when the day comes.  Nextel expects that its high network quality rating (second and just below Verizon in a JD Power survey), highest customer satisfaction rating (JD Power), and sustained customer momentum into the fourth quarter will help the company "clean up " after porting starts.
Donahue said that the inter-carrier testing with Cingular and Sprint (which it has signed porting agreements with) were going  "OK " but that he expects a high rejection rate in the first few months of portability, possibly reaching as high as 75%.  This would lead to a lot of manual entries for the companies, and could create delay times for porting measured in days or weeks rather than hours.  Nextel expects that the first 60-90 days of portability to be very tough.
Pricing: Nextel is prepared to act rationally once portability comes around, but says it is prepared to respond if other carriers get aggressive in terms of pricing.  Aside from that, however, Donahue sees other wireless management teams as far more rational on pricing going forward than some have been in the past.  Though we continue to model ARPU coming down over time, we do hope that he is correct and that industry pricing remains as stable as it has been in 2003.
Boost Mobile: Boost added 102,000 subscribers this quarter, in what is essentially one market (California, though Las Vegas also has Boost), which we think indicates the huge potential market available for Nextel's product.  The company has talked about growing the size of the offering in 2004 by a few markets and eventually a national roll-out of Boost.  Nextel is expecting to be able to offer customers a handset which it will be paying less than $100 for, something we see as an absolute requirement before really entering the prepaid market.  With that phone Nextel could compete with Virgin Mobile and GoPhone-level handset prices without getting crushed on the CPGA.
Spectrum Swap Consensus Plan: Nextel remains confident that the consensus plan can come through in one piece, and that the company can get both an 800 MHz rebanding and the 10 MHz of 1900 spectrum that it has proposed.  While Donahue pointed out that both the FCC's wireless and engineering bureaus are behind the idea of a rebanding rather than a filter-based solution, we remain skeptical that this will result in the adoption of the full consensus plan.  Our contacts continue to indicate that the FCC is unlikely to assign Nextel auctionable spectrum, despite the cash commitment from Nextel.

ESTIMATES & GUIDANCE

Guidance Raised. The company raised 2003 EPS and net add guidance by 15%, EBITDA guidance by 5%, and is now calling for FCF of $1 billion up from $600 million.  Guidance of $1.15 in EPS includes an expected $70 million expense associated with the further announced buyback of approximately $1.3 billion in debt, which is down from $132 million in the third quarter.  (Guidance of $70 million was before further debt repurchase announcements, it is unclear if that was included. We use a calculated $84 million in our EPS estimate.) Free cash flow of $1 billion includes $141 million for the purchase of MMDS spectrum from MCI, the closing of which will depend on MCI's emergence from bankruptcy. If the deal does not close before the end of the fourth quarter FCF will be expected to be higher.  We have updated our 4Q03 and 2004 estimates to reflect the quarter's results and the company's new guidance. While the changes to our customer additions, revenue, and cost lines are minimal, we have made some changes below the EBITDA line and outline those below.

Subscribers: Although we have not changed our net subscriber additions for the fourth quarter, we did bring our churn estimate down slightly to account for Nextel's excellent quarter. Our 1.6% estimate is based on an October and November churn rate of 1.4% (in line with 3Q) and a December churn rate of 2% (in line with our 1Q04 estimate) to account for portability.  Our 2.232 million net addition number for 2003 puts us slightly ahead of guidance, and we see the estimate as conservative.
Revenue: Our average revenue per user in the fourth quarter is up just over $1 to account for Nextel's outperformance this quarter. Though from a higher base in 3Q, we still look for the ARPU to be down sequentially more than $2 in the fourth quarter, and still down 1% year to year. This is slightly more than the same decline in 2002 when ARPU was down $2, and we include a little extra for the risk of portability.
In 2004 we have a similar situation, in which we continue to look for Nextel to show 3% annual ARPU declines which we see as conservative. From a higher 2003 base, our 2004 calculated ARPU rises to nearly $68 from $67 previously.  In addition to regular service revenue, we have increased our estimate for Nextel's  "Other Revenue " line due to the success of Boost Mobile, which was one driver behind an increase in the other line from $28 million in the second quarter to $46 million in the third. We estimate that approximately 1/4 of the $46 million was from Boost service revenue, which is based on a $40 Boost ARPU.  (Note that we increased cost of service slightly as well to account for this.) EBITDA: With no changes to net additions or churn in the fourth quarter or 2004, our cost lines are little different from previously. Our EBITDA increases by $80 million in the fourth quarter to reflect higher revenues and by $28 million in 2004.
Depreciation and Amortization: This was a big miss for us this quarter, and well below guidance year-to-date. We have brought our expectations for D&A down substantially to reflect that discrepancy.  We bring D&A down $81 million in the fourth quarter and $127 million in 2004, which still assumes a steady quarterly increase.  This may prove to be conservative as well, and we may revisit the number when Nextel provides 2004 guidance.
Interest Expense: Given Nextel's continued debt refinancing and the $1 billion which was raised in equity this quarter, we have lowered our estimate for Nextel's interest expense substantially both for the fourth quarter and for 2004.  We now look for $842 million in 2003 net interest expense and $655 million in 2004.  Our model assumes that Nextel does only the debt refinancing that has been announced, leaving additional upside for EPS on any future announcements.  2004 interest expense is highly sensitive to LIBOR, on which the interest rate for Nextel's $4.5 billion in drawn bank credit facilities is based.  We assume an average LIBOR of ~2% in 2004, up from ~1.1% today.  Income from International: Nextel this quarter showed a swing from negative $35 million to positive $11 million from its investment in NII Holdings.  We extrapolate from that to an equivalent amount in the fourth quarter.  In 2004, the First Call consensus estimate for Net Income at NII is $108 million.  Nextel owns 36% of that, which translates to $40 million on the Nextel income statement.  Although, given the ramp-up from negative territory in the second quarter to $11 million in the fourth, there could be upside for the number.  Premiums for Debt Repurchase: We have raised our 4Q expectation to $84 million (from zero) for Nextel's expected debt repurchases. That includes both the premiums paid on buying the bonds and related fees. Our calculations can be found in the table below.
Debt Buybacks Announced as of October 17, 2003

To be redeemed in 4Q
Amount        Notes     Price    Premium
497           9.75%   102.4%     12.1
999           9.95%   105.0%     49.7
284           4.75%   102.0%      5.8
268             12%   106.0%     16.1
2,048                            83.7
Note: Dollars in millions.

Source: Company reports, Bear, Stearns & Co., Inc. estimates.  Capital Expenditures: After our meeting with management Friday we are bringing our 2004 capital spending estimate up to $1.6 billion from $1.4 billion to account for an expected increase in the company's network coverage.  Nextel has discussed building 1500 cell sites in 2004 and around 5000 over the next three years, which we would see as money well spent.  Customers' biggest complaint to us in the past on Nextel has been the coverage level, and we believe that more sites will allow Nextel to tap a wider group of customers.

Summary of Key Changes in 2003 (Dollars in millions, subscribers in thousands)

4Q03E 4Q03E-Prev% Change 2003 Guidance2003E
2003E-Prev%
Change
Net subscriber additions   515      515     0%      2.2 mm 2,232
2,106
6%
Ending subscribers  12,844   12,718     1%            12,844
12,718     1%
Total churn           1.6%    1.7%     -6%              1.6%
1.7%     -5%

ARPU                   $68      $67     2%               $69
$68     1%
Total revenue        2,906    2,726     7%            10,720
10,320     4%

EBITDA               1,158    1,078     7%       4,100 4,197
4,059     3%
EBITDA margin        44.1%   42.3%                     42.7%   42.1%
EPS                  $0.37   $0.29             $1.15   $1.15   $1.10
Capital expenditures   650      540    20%       1,800 1,769
1,796    -2%

Source: Bear Stearns & Co. Estimates

Summary of Key Changes in 2004 (Dollars in millions, subscribers in thousands)
2004E      2004E - Prev     %
Change
Net subscriber additions                 1,500
1,500         0%
Ending subscribers                      14,344
14,218        1%
Total churn                             1.9%
1.9%            0%

ARPU                                      $66
$66           0%
Total revenue                           12,169
11,553        5%

EBITDA                                   4,753
4,725         1%
EBITDA margin                          42.9%           43.7%
EPS                                    $1.78
$1.63            9%
Capital expenditures                     1,600
1,400         14%
Source: Bear Stearns & Co. Estimates
SENSITIVITY ANALYSIS ON 2004 ESTIMATES
$1 Change in 2004 ARPU Equals $163 million EBITDA and $0.14 EPS
(Dollars in
millions)
Source: Bear Stearns & Co. Estimates

10 b.p. 2004 Churn Equals $76 million EBITDA and $0.07 EPS (Dollars
in
millions)
Source: Bear Stearns & Co. Estimates

100 b.p. 2004 EBITDA Margin Equals $111 million EBITDA and $0.10 EPS
(Dollars
in millions)
Source: Bear Stearns & Co. Estimates

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