Published November 07, 2012
SAO PAULO – Investors in Nextel operator NII Holdings are betting that Brazil could give the company a much needed lifeline as mounting rivalry and outdated technology threaten its business model. They may be in for a disappointment.
A flagging economy and regulatory pressure have put an end to years of easy growth in Latin America's biggest wireless market, intensifying competition and leading Mexico's America Movil SAB and Spain's Telefonica SA to target NII's higher-paying corporate clients.
NII's subscriber base in Brazil, where the company earns half its operating profit, shrank last quarter for the first time as other carriers tempted users with unlimited calls on their bigger, faster networks. As NII undertakes a costly transition to third-generation (3G) technology by year-end, some investors fear those efforts could actually speed clients' departure.
"The question is: Will this 3G rollout make NII competitive after all? When investors find the answer, many of them will run for the exits," said Christina Ronac, a desk analyst with investment banking firm Gleacher & Co in New York.
Shares and bonds of NII are down 64 percent and 13 percent this year, respectively, on fears the strategy may fail. The treacherous road ahead for the company also underscores the shifting tastes of Latin America's emerging middle class, which has grown increasingly savvy about smartphone technologies that were unheard of in the region just a decade ago.
The company's subscriber base in Brazil fell by 53,000 in September, extending losses to 85,000 clients in the quarter as rivals grew. Analysts polled by Thomson Reuters predicted a loss of 40,000 clients in the period.
Many analysts are still urging investors to keep the faith. Eight of 18 analysts covering the stock rate it a "buy" and six as "neutral," Thomson Reuters data showed, as they point to the rollout of 3G to turn around the company's fortunes.
"We believe the worst is behind," Jennifer Fritzsche, an analyst with Wells Fargo Securities, wrote last month, citing the deployment of new networks in Mexico, Chile and Peru. She has a "market perform" recommendation on the stock.
NII, which releases third-quarter earnings later on Wednesday, declined repeated requests for comment.
NOT FOCUSING ON CUSTOMER WISHES?
While a cooling market and deeper-pocketed rivals would be a challenge for any specialty carrier, NII also faces a self-imposed hurdle: its earlier strategic choice of the increasingly obsolete push-to-talk network.
Since 1997, NII Holdings, originally the foreign arm of Nextel Communications, has offered PTT services on a specialized iDEN network in Latin America, allowing high-use corporate clients to use their cell phones like walkie-talkies.
Yet analysts say newer technologies have passed NII by, with sophisticated consumers demanding smartphones on mobile data networks. Smartphones have an array of options for instant messaging that mimic Nextel's push-to-talk function.
NII has budgeted $1.5 billion this year and nearly as much in 2013 to build out its 3G infrastructure as it subsidizes handsets with the push-to-talk features on the new networks. But some investors say the strategy is too focused on the walkie-talkie-inspired features and less on what consumers want: mobile video, social networking and data-heavy applications.
'RIVALS ALREADY MOVING TO 4G'
NII is hoping Brazilians embrace the launch of its 3G network, but not everyone is convinced. Priscila de Paula, a Sao Paulo-based video producer who has stuck to her Nextel device since 2005, may hang it up for good.
She said the "poor" Internet quality on her Nextel phone prompted her to buy another mobile phone to use data services. At this point her monthly bill is losing to other arguments in her decision to keep her Nextel.
"Nextel is going 3G while rivals are already moving to 4G -- Nextel had better roll out a convincing product," she said.
Where NII has already launched its new network, the results have been mixed.
In Peru, where NII finished rolling out 3G service this year, the subscriber base shrank by 6,000 in the second quarter, versus additions of 60,000 a year ago. The Peru case also shows the diminished profitability of running separate iDEN and 3G services -- which may happen in other markets once the new technology arrives.
In the United States, Sprint Nextel plans to scrap its iDEN network in June 2013 and force users onto its 3G network. It may take heavy subsidies or two years of coaxing for NII to do the same, Gleacher's Ronac said.
BULLS VS. BEARS
Declining revenue, an eroding subscriber base and plunging profit margins have led more bearish analysts to forecast deeper losses and higher net debt for NII in coming quarters.
By June 2013 the company's net debt may climb past four times its 12-month estimated earnings before interest, taxes, depreciation and amortization, wrote Carlos Sequeira, an analyst with BTG Pactual Group, in a recent note. EBITDA, as the indicator is known, is a gauge of operational profitability.
The carrier could burn through most of its $2 billion of cash on hand by the end of next year, according to calculations made by Gleacher's Ronac and Thomson Reuters.
NII has already recognized that revenue will fall short of its original 2012 forecast. In August it cut revenue estimates for this year by $1 billion, to $6.1 billion. On Tuesday, it announced plans to cut about 20 percent of the workforce at headquarters in Reston, Virginia, reassigning some positions to Latin America.
NII's strategy "is an accident waiting to happen," said a Sao Paulo-based fund manager who has no positions in NII bonds or stocks.
In the meantime, it may get harder to free up cash for investments and debt servicing,. NII could struggle to sell and lease back its cell towers as a drop in EBITDA makes it a less appealing lessee.
Such an agreement may also hinge on a successful 3G rollout, according to analyst Jeff Fan of Scotiabank GB&M, as more stable revenues will show it can keep up with leasing payments. More bullish analysts also see upside for NII in the Brazilian government's push to cut fees that incumbent carriers collect from smaller rivals.
Regulators may implement a "partial bill and keep" system in which interconnection fees could be eliminated through 2016. NII would see a boost of several percentage points in its EBITDA margin overnight, Fan wrote in a report last week. He rates the stock a "sector outperform."
New measures also call for the largest wireless carriers to share up to 10 percent of their networks, ducts and towers with smaller rivals - a move that would benefit NII Holdings, said Lucio Aldworth, a Goldman Sachs Group analyst who has a "neutral" recommendation on the stock. Telefonica's Vivo brand has 19 times as many subscribers as NII's Nextel.
However, NII's benefit from such a policy would also depend on a successful transition to its new network, a former Brazilian government official told Reuters on condition of anonymity. The partial bill and keep system will only apply to NII users on its 3G network, not to those on the current iDEN system.
This process of implementing the 3G network and luring clients to it "will be very slow," said Vera Rossi, a senior telecom analyst with Barclays in New York who has an "underweight" recommendation on the stock.
(Editing by Todd Benson and Prudence Crowther)