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Get Four
|  | OCTOBER 25, 2004
By Kenneth M. Leon Nextel Gets an Upgrade Its vast plans for 3G network improvement and for extending service to fast-growing markets prompt S&P to rate it a buy Nextel shares (NXTL ; recent price: $25) are down 11% year-to-date, well below the performance of other wireless carriers. We at S&P upgraded the stock on Oct. 12 to our highest recommendation of 5 STARS, or buy, based on our belief that it has the potential to rise given Nextel's strong competitive and financial performance, continued reduction in outstanding long-term debt, and improving cost of capital. We believe Nextel, the fourth-largest U.S. wireless phone carrier, will be able to resolve two fundamental risks that we believe have pushed the shares down from its 52-week high of $29.37 last January. The first risk is the amount of money it will have to pay the Federal Communications Commission for spectrum allocations. The other risk is that in the meantime, Nextel may lag behind its peers in upgrading its network to third-generation (3G) technology. SPECTRUM-SWITCHING. Following our recent discussions with senior Nextel management, we believe we can now better predict the capital outlays for FCC spectrum-reallocation costs and the capital spending required for 3G technology than we could earlier this year. After subtracting these estimated costs, plus forecasted annual capital expenditures and interest costs, we believe Nextel may still generate cumulative free cash flow of $5 billion or more in 2004-06. As of Sept. 30, Nextel had approximately $1.7 billion in cash equivalents. The FCC has ordered Nextel to pay approximately $3.2 billion net of transition costs and the value of the licenses it already holds. Nextel will move its network from the 800-megahertz (MHz) band to 1,900 MHz. This is part of the FCC's spectrum-realignment plan, announced on July 8, to eliminate interference with public-safety operators in the 800-MHz band. The FCC indicated it had intended to adopt and implement a band-realignment plan similar to the joint proposals submitted by Nextel and the leading public-safety associations, including Nextel's receipt of a license for 10 MHz of spectrum in the 1,900-MHz band. The joint proposals are known as the consensus plan. Nextel's competitors vehemently oppose the FCC order because they believe Nextel is paying below fair-market value for the 1,900-MHz band. In its written public order, the FCC made an extra effort to address and refute most of the objections to the consensus plan. At an analyst conference on Oct. 6, Nextel management stated that it believes some inconsistencies remain in the final order related to public safety and company issues that need to be resolved. After two-and-a-half years, Nextel is hopeful the spectrum swap order will be completed in the next 60 days or by yearend. READYING FOR 3G. Once these regulatory matters are completed, we believe Nextel will make a decision sometime in the first quarter of 2005 about 3G technology and selected vendors. In the meantime, it's deploying a 2.5G technology, WiDEN, from Motorola (MOT ; buy; $17) to improve data rates up to 80 kilobits per second. Nextel has worked closely with Motorola on its current iDEN network and continues to expand voice capacity. Excluding 3G-capital outlays, we expect capital spending to be approximately $2.4 billion in 2004 and then decline to $2 billion in 2005. Besides network upgrades that are under way, Nextel is expanding its network's geographic footprint to extend service coverage in fast-growing markets. More than 600 new cell sites should be deployed in 2004, and Nextel has a target of 2,200 to 2,500 new cell sites for its core network. What about 3G technology and vendor selection? In February, 2004, Nextel started a market trial in the Raleigh-Durham (N.C.) market, using Flarion Technologies' FLASH-OFDM wireless technology. The trial has been a success, with data rates up to 3 megabits per second with broadband wireless access to laptop and desktop computers, pocket PCs, and similar devices in a mobile setting. One of Nextel's concerns is time to market and vendors' capability to delivering OFDM infrastructure and handsets. In our opinion, Flarion is only a development-stage company and cannot meet the 3G product requirements to manufacture and install a $2.5 billion network and ship 3G handsets in high volume for Nextel. ""BEST-IN-CLASS" TECHNOLOGY. Nextel's management has asked vendors to submit proposals, either using Flarion's OFDM technology, Qualcomm's (QCOM ; buy: $43) CDMA 1xEV-DO, or submit bids on both. For those vendors supporting the CDMA technology, Nextel will give careful consideration only to those proposals that offer a distinct technical advantage to Nextel's competitors, Sprint (FON ; hold; $20) and Verizon Wireless, which are already deploying 1xEV-DO. Nextel management has stated its top priority is best-in-class technology, vs. a first-to-market move to gain an advantage in the market. We're not sure how the vendors can offer a differentiated product from the CDMA 1xEV-DO networks being deployed by Verizon Wireless or Sprint. In our view, the enhancements would have to be in the service applications instead of the core technology. In our view, Nextel will begin to launch commercial service for 3G services in late 2006, but it needs to begin network testing and deployment in 2005. Qualcomm's CDMA 1xEV-DV technology, which will be available in late 2005, has a faster data rate than its CDMA 1xEV-DO and is expected to be comparable to Flarion's OFDM technology. Nextel already has a joint partnership with Qualcomm called Q-Chat that allows Nextel customers to roam with CDMA networks outside the U.S. market. Vendors under consideration by Nextel, in our view, are Lucent Technologies (LU ; hold; $3.50), Motorola, Nortel Networks (NT ; hold; $3.40), and LM Ericsson (ERICY ; hold; $29). While Motorola has been a sole supplier to Nextel for iDEN infrastructure and handsets, we believe Nextel desires at least two strong vendors that can execute and deploy the 3G-network in a timely manner. We believe Motorola may have an inside track with its knowledge in OFDM, but it's probably too early to call the vendor outcomes. NO. 1 PURE-PLAY. In the end, Nextel's vendor decision on 3G may be one of the last major land grabs for equipment suppliers. With the planned acquisition of AT&T Wireless ((AWE ); hold; $16) by Cingular Wireless, Nextel will become the largest pure-play in the wireless-services industry. In our opinion, management has a strong track record in meeting its strategic and financial objectives. We believe Nextel shares are undervalued and should be a core holding in the U.S. wireless industry. Our 12-month target price of $30 is based on a blend of forward price-to-earnings multiple (using 16.7 times our 2005 earnings projection) and enterprise value (6.6 times our 2005 EBITDA estimate) analyses. With Nextel priced below peers on a p-e basis at 14 times our 2005 EPS estimate of $1.80, we recommend buying the stock. Risks to our recommendation and target price include increased competition from Verizon Wireless and other leading wireless carriers in the business and government markets, where Nextel has the largest market share, regulatory delays on new radio spectrum to be awarded to Nextel by the FCC, and higher cash payments for the new spectrum, which may be well in excess of our $3 billion estimate. Note: Kenneth Leon has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com  Analyst Leon follows telecommunications wireless equipment and services stocks for Standard & Poor's Equity Research Edited by Karyn McCormack
BW MALL
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