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Technology Stocks : NEXTEL -- Ignore unavailable to you. Want to Upgrade?

To: SteveG who wrote (8998)	4/6/1999 7:14:00 PM
From: SteveG	Read Replies (4) \| Respond to of 10227

From Lehman this AM (who BTW don't think WCOM does NXTL for a NUMBER of reasons, not least of which is cost. For instance, $24B in fully diluted enterprise value could buy a LOT of GSM licence holders): ~~~~~~~~~~~~~~~~ (part 2) WHAT ARE THE SHARE PRICES OF PCS, WWCA AND NXTL CURRENTLY ASSUMING? It's safe to assume that if investors are still buying shares of NXTL, WWCA and PCS based on expectations of a takeover that their assumptions regarding private market values for these shares differ from our own. Consequently, we thought it would be interesting to take a look at what assumptions need to be made in terms of discount rates and long-term subscribers in order to get to the current share prices. We assume zero private to public market discount, i.e. takeout value. First let's look at weighted average cost of capital (discount rates). Using our current cash flow estimates and publicly available debt rates, we can back into the implied required rate of return of equity investors which is being reflected in the share prices of the three stocks. We apply a normalized debt to equity ratio of 35%. Based on this analysis we find that the discount rate being implied by current share prices for the three stocks ranges between 11.0% and 11.6%, as shown in the table below. Similarly, implied equity rates of return are tightly clustered between 13.6% and 15.2%. Using 30-year US Treasury Bonds which are trading at around 5.6% as a proxy for risk free rates and a beta of 1.5, equity risk premiums for this group between 5.3% and 6.4%. Curiously, as of Monday's closing prices, it appears that investors were requiring a slightly higher return from Sprint PCS than from Nextel. This may partly be due to expectations that Nextel will be strongly EBITDA positive for the first full year in 1999 while Sprint PCS has a few more years of projected EBITDA losses. COMPANY DISCOUNT RATE TAX EFFECTED IMPLIED IMPLIED BY DEBT DEBT THEORETICAL EQUITY REQD CURRENT PRICE RATE RATE DEBT/EQUITY RATE OF RTN Sprint PCS 11.0% 8.5% 6% 35% 13.9% Western Wireless 11.6% 7.8% 5% 35% 15.2% Nextel 11.0% 9.8% 6% 35% 13.6% Now turning to cash flows, how much do we need to adjust upward our assumption of 2007 penetration in order to get to current share prices? The table below summarizes Lehman Brothers' current assumptions of 2007 penetration and 2007 subscribers and penetration/subs which would get us to the current share prices. Again, we assume no private to public market discount. As the table shows, Sprint PCS' and Western Wireless' share prices reflect penetration rates in right in line with those which we assume and Nextel's is substantially above. Pen & Subs Closing LB 2007 PEN LB 2007 LB END OF REFLECTED IN PRICE ESTIMATES SUB EST (M)# 1999 PMV 4/5/99 PRICE 4/5/99 Sprint PCS 7.6% 20.1 $53 7.6% & 20.1 $51.00 WWCA - cellular 9.8% 0.8 $38 9.8% & 0.8 $38.13 VoiceStream 7.8% 2.1 7.8% & 2.1 Nextel 3.8% 9.8 $24 6.8% & 17.8 $39.63 # Excluding Affiliates In order for investors to pay the current share price for Nextel, one must be comfortable that either the discount rate of 13% which we are using is too high by around 200 basis points or that Nextel will achieve penetration substantially above what we are estimating or a combination of the two. Even assuming a discount rate of 12.5% (between the 12.0% rate we use for mature cellular operators and the rate of 13.0% used for PCS operators), we need to assume 2007 penetration of 6%, 2007 ending subs of 15.1 million and capex per ending sub of $723. This would also require a solid pick up in the near term quarterly net subscriber additions to the 450,000 to 500,000 range. Given that our capex per ending sub estimate for Sprint PCS is just over $700 in 2007 and Nextel's spectrum limitations (around half as much spectrum in major urban markets as most of its competitors), we consider the capex assumptions in particular a stretch when joined with a 17.8 million subscriber figure. The table below provides a summary of the ARPU, EBITDA margin and capex per ending sub assumptions for 2007 which we use to generate our private market values. EBITDA CAPEX PER SUBS (M) ARPU MARGIN ENDING SUB Sprint PCS 20.1 $40 53% $704 WWCA - cellular 0.8 $42 52% $434 VoiceStream 2.1 $40 49% $604 Nextel 9.8 $44 49% $908 The market will continue to look for any signs that a deal is imminent or not. If we see Nextel do a public debt refinancing this could be poorly received by the market which might see the refinancing as a signal that a deal is not impending due to the normal blackout restrictions associated with such a public deal. Furthermore, in the past WCOM has expressed concerns about the dilutive impact to EPS on a wireless acquisition. However, their apparent recent interest in ATI indicates that perhaps they now believe that there could be some strategic benefits to holding wireless assets. We believe WCOM is best positioned to accelerate Nextel's business plan and Bernie Ebbers is the best person to sell the strategic rationale of a combination. Even so, given WCOM's previously indicated sensitivity to EPS dilution, valuation will be an important determinant of any deal. In terms of Sprint PCS, the lock up on the shares held by the cable partners expires on May 23rd and we may see the cable partners seek to divest some of their holdings following that expiry. It is unclear to us that a cable partner sale of shares would signify no likely deal, the cable partners have limited voting rights and no board seats, so theoretically takeover discussions could occur without their knowledge. Also, given the tracking stock structure of Sprint - any premium on takeover would be allocated between PCS and FON and there is no guarantee as to how the premium would be allocated between the two shareholder groups. In conclusion, we would caution that the prices now being paid in the public market for these potential takeover candidates are very full. New investors who are buying NXTL, PCS and WWCA today need to be comfortable that a deal will happen soon and at a premium. If no deal were announced in the near term, we could see these stocks trade off sharply. Additionally, given the full valuations currently being paid in the public markets, there is some risk that deals actually get done with little or no premium to public market values.