Techway Cover Story
What's Next for Nextel?
A gamble at the start, the Reston cellular firm is raising the stakes by flouting conventional wisdom
Keith Epstein
Special to Washington Techway
Wednesday, April 24, 2002; 2:04 PM
"Look at this thing." Tim Donahue laughs as he lifts it - a cell phone as large and heavy as a brick. "This is the phone McCaw tried to recruit me with. I must have been out of my skull."
Donahue shakes his head in a kind of disbelief, recalling that day in New York in 1995 when legendary cellular pioneer Craig McCaw asked him to help build a wireless national telephone network out of a faltering firm known as Nextel.
McCaw had pumped more than a billion dollars into the fixer-upper, cobbled together from local mobile radio services for taxicabs. Now he wanted Donahue, a veteran from McCaw Cellular, and Dan Akerson, a onetime MCI president, to launch a daring assault on the wireless marketplace. People wouldn't just make telephone calls on the run, they would be "always on" with associates.
Donahue loves a challenge, the tougher the better, but Nextel seemed to have almost nothing going for it. Sound was poor. Top management and sales were weak. The phones dialed out but looked and functioned like walkie-talkies. The "Lingo" weighed more than a pound. It had to be cranked from frequency to frequency, by twisting a knob at the top.
"And look at that antenna," groans the Nextel CEO. "I must have been nuts. McCaw said to me, 'This is the future, Tim: Push to talk.' "
Barry West, Donahue's chief technical officer, keeps the Lingo, along with other outmoded generations of Motorola "children" he helped father, atop a bookcase in his office at Nextel's Reston headquarters. He calls the collection his "rogues gallery." "We should have been dead at birth," says West. "People thought it would never amount to much more than a few taxicabs talking to one another. Now we have 9 million customers. Nine million! I tell you, the cellular telephone industry is not for the faint of heart."
Muses Donahue about his risky career move six years ago: "It was the smartest decision I ever made."
If only the market hadn't soured, sweeping cellcos out with the tide. If only they weren't laden with so much debt, in Nextel's case a staggering $14.9 billion. If only wireless stocks hadn't sunk to record lows, Nextel's tumbling in two years by 90 percent, finally clunking to the bottom Feb. 19 at $3.55 a share, the lowest in 10 years of public trading (the stock closed April 17 at $6.04 a share). It was a long drop for the nation's fifth largest wireless carrier, a company once valued by the market at $50 billion and wooed by AT&T Wireless and WorldCom.
If only markets abroad also weren't suffering, as in Latin America, where struggles of NII Holdings, Nextel's separate international operation, prompted Nextel last month to write down the investment by $1.6 billion. If only the increasingly wary Street would focus on operational results, sales figures, product differentiation, uniqueness of customers. Then perhaps everybody would be agreeing with Donahue now.
Last year, despite full-blown recession and a national tragedy, the company added nearly 2 million customers and generated an operating cash flow of $2 billion. In the first quarter of 2002, Nextel reported revenue of $2.16 billion, up 24 percent from the same period a year earlier, and added another 502,000 subscribers, bringing its total to 9.2 million.
At a time when most of the wireless industry is in turmoil, and few are meeting their numbers, Nextel still meets or exceeds them. Today, its small sleek phones are like walkie-talkies on steroids. Not only are new subscribers signing up at a steady rate, Nextel's customers are the industry's most valuable. Nine in 10 are business customers, who are willing to pay more. Each returns more revenue, $68, than the industry average, $49. The company's 2.1 percent churn during the past 13 months was the industry's lowest.
And yet like its competitors, Nextel borrowed heavily to build a network. It will be at least 2004 before the company reaches positive cash flow, and when it will turn a profit is anybody's guess. Since 1987, the company has spent $9 billion more than it has taken in. In the first quarter of 2002, it lost $654 million.
"We cannot know when, if ever, our cash flows from our internal business operations will support our growth and continued operations," the company stated in a March 29 filing with the Securities and Exchange Commission. Meanwhile, the competitive environment has changed radically.
The prices subscribers pay for mobiles are in free fall, from an average 56 cents a minute to 14 cents a minute last year. With more than half the U.S. population - 130 million - now using cellular phones, subscriber growth is slowing. Consolidation seems inevitable.
Yet Nextel is staking its future on technology that differs from any plausible suitors - iDEN, its original technology. While competitors are spending an estimated $30 billion to develop third generation, or "3G," technologies to boost data and voice transmission speeds, Nextel is purposely sticking with what it calls 2.5G.
Indeed, the company that started with a gamble - on a unique part of the radio spectrum and by targeting businesses who pay a premium for data and "Direct Connect" voice links for up to 100 co-workers - is raising the stakes on the same wager. Such persistence could prove to be Nextel's undoing - or remaking.
"They're a fish out of water," says Drake Johnstone, telecom analyst with Richmond-based Davenport & Co. "All the other carriers are upgrading their networks to worldwide standards, but Nextel's iDEN remains unique. If they can't upgrade to newer technologies, they could begin to lose customers to competitors because the competitors will provide faster speeds."
"There's been a lot of hype about future platforms in this industry," counters Donahue. "I'm a big fan of data. It has real legs. But I'm not convinced you need the speed these people are talking about. We are on absolutely the right path."
To understand Nextel's unique path almost requires an advanced degree and insider's knowledge of software and bandwidth, to say nothing of a superhuman tolerance for acronyms.
Unlike the traditional circuit switching of most telephone networks in the United States, iDEN technology separates information into bundles, or "packets," delivering them to receivers over varying frequencies. Conventional wireless relies on keeping open a specific channel during a call, while packet-based technology speeds up data transmissions. More transmissions can be compressed into the available radio spectrum. There are no pauses; during gaps in a call other bits of voice or data from other calls fill the spaces. This means no waiting to connect; a subscriber can be "always on."
Until recently, Nextel alone had packet-switched networks. Now the other wireless carriers are starting to "packetize" their future networks, too. And they want to leapfrog Nextel, providing so much speed that future subscribers will be able to view video, surf the Internet, use corporate intranets and stay in constant touch from their mobiles.
AT&T Wireless is going for a 3G technology known as GSM, launched late last year in certain markets. Verizon Wireless and Sprint PCS favor an alternative called CDMA. Cingular Wireless also prefers GSM. The fragmentation hints at possible mergers - and, for Nextel, possible isolation.
Within Nextel, naturally, the view is that the company is already the leader - and it's the other wireless carriers who are catching up.
Central 3G goals - using packet-based networks to create faster data rates and always-on connections that appeal to corporate customers - are, after all, Nextel's prime achievements. The company already leads the pack in delivering data services; one in five of its customers use them, often for specialized business-related applications - a proportion far greater than any competitors. It aims, without upgrading to 3G, to double capacity within existing technology by next year, enhancing speeds from 19.2 kilobits per second to 50.
Now, competitors are gunning for the company's unique services and its valuable customer base. "Other carriers are taking dead aim at what Nextel is offering," observes Ken Hyers, senior wireless carrier analyst for In-Stat/MDR, a high-tech market research firm.
Sprint claims it can offer a push-to-talk service within a year, and both AT&T and Verizon are targeting the enterprise customer. (This story, for instance, was e-mailed to Techway's offices in Arlington as a Word attachment over Verizon Wireless' new Express Network, that company's first step toward 3G, using technology known as 1XRTT. Establishing a connection to the Web took only a few seconds and speeds were superior to landline dial).
"Nextel's not in trouble in the near term," says Hyers. "But they are in danger of having their market poached by other national carriers."
It's hardly clear, however, exactly what 3G will offer, or whether there will be sufficient demand. Will customers be willing to pay the premium for wireless video and Internet access? Will subscribers really want to spend money for the luxury of e-mailing photos from the car, designing presentations while waiting at the gate, or video-conferencing with fellow executives?
As Roger Entner, wireless mobile services program manager at The Yankee Group, puts it, "I have yet to see why a plumber needs high-speed data to do his job. He just needs someone to say, 'Hey, Joe, your next job is in Annandale, and after that you have to go to Chantilly.' " In short: will businesses be able to do anything with 3G that Nextel customers can't do now?
To some, that's the genius in Donahue's strategy. "They're playing it smart by waiting and seeing, by not making a choice too early," says Hyers. "And guess what? They don't have to - yet."
In the current climate, of course, hardly anybody is in the mood to wait. The wireless wipeout only fired the quest for a catalyst that could get the industry winning again. One investment firm's analysis last fall, coinciding with the World Series, featured a cover illustration of a baseball stadium in which 1xRTT and CDMA 2000 were vying with GPRS and WCDMA for the "Wireless World Series." Billboards in the outfield read "Got data?" and "BANKRUPT."
With so much at stake, Nextel is hedging its bets slightly. It is exploring, with Qualcomm, integrating "Direct Connect" push-to-talk with 3G CDMA architecture. Donahue has been telling associates Nextel could borrow more later and overlay a network upgrade to accommodate a 3G platform.
For the most part, however, the company remains stubbornly contrarian - some would say by necessity, since it may be the only affordable option. Others say the strategy is in keeping with the company's culture and Donahue's personality.
A liberal arts major with a critical mind, he cut his teeth in sales almost before he had teeth - traveling with his father, sole distributor of a key part of the zipper. Later, as an adult, he succeeded in re-purposing Ben Franklin five-and-dimes into outlets for crafts supplies. Donahue thrives on challenge and a customer-focused entrepreneurial spirit, first learned from his father and never abandoned at Nextel, associates say.
William Kennard, chairman of the FCC until January 2001, could have signed on with any number of telecommunications companies. Instead he joined Nextel's board "because of their dogged entrepreneurial persistence." For years, Kennard was fascinated by the unconventional struggle of Nextel's founders to adapt "almost out of nothing" a nationwide network. People have always said Nextel couldn't get things done, and yet the unconventional thinking of its management, he argues, makes things happen.
"Anyone who tells you 3G is the savior of the wireless business is going to have egg on their face," predicts Kennard. "Everybody's focused on how much bandwidth to drive in a device, not what people want or are willing to pay. Nextel's already figured that out."
Some appear to be buying into such a view - literally. Earlier this month, Baltimore-based Legg Mason and legendary fund manager Bill Miller were quietly completing a quarter-long acquisition of 16.2 million shares. Legg Mason now holds 82.9 million shares, making it the second-largest public investor in Nextel. Even McCaw - whose $8 billion stake two years ago has dwindled to less than $400 million - owns less. Only Motorola owns more.
Although aggravated by the conventional wisdom, Donahue prefers to look farther ahead - to a future in which people are inevitably "freed from a tethered wire." He believes investors are "overly exorcised about balance sheet issues and revenue issues. People are going to a wireless world, and it's going to spell opportunity for all of us."
Donahue again ponders that first phone, the Lingo, turning it over in his hands. "Here's a company no one ever gave a chance to. They thought we'd be a niche player and appeal to taxi cab drivers."
His eyes turn to the latest model, a small new sporty clamshell, the Java-enabled i90c, which is being snapped up at twice the anticipated rate. "But here we are," he says, his eyes lighting up, "delivering a superior product to customers and being an innovator. We're a strong and successful company that retains an entrepreneurial spirit. And that means we'll do more than just weather this market. Just watch."
Keith Epstein is the Tampa Tribune's Washington correspondent.
washingtonpost.com |
