Description

NII Holdings, NIHD, stock has gotten crushed over the past year, falling over 70% due to numerous issues, like intensifying competition in its largest market, management misexcecution, and network upgrade issues.  Despite the results of the past year being abysmal, there are signs that a turning point operationally is approaching.  In the meantime trough valuation on cash flow, asset value, and the potential for M&A should provide downside protection.

NIHD provides wireless communication services under the Nextel brand inLatin America.  The target customer is primarily small and medium sized business users.  Operating companies are located inBrazil,Mexico,Argentina,Peru, andChile.  NIHD generally provides services in the major urban and suburban centers where population densities and concentration of businesses lead to the greatest efficiencies.  NIHD’s legacy network utilizes iDen, a technology developed by Motorola, which offered superior and differentiated services, and therefore attracted a high value customer to NIHD over the years, as measured in terms of high ARPU and low churn.  However, iDen was only used by Nextel and there was no clear path to migrate to newer generations of wireless technology, so NIHD is currently building 3G WCDMA networks in its markets, which requires significant investment. 

The stock has been written twice on VIC in the past, five and ten years ago, so refer to those for historical perspective, but much has changed in the ensuing years.  All currency numbers are in USD.

On the 2Q12 conference call, management again lowered guidance for 2012, reducing revenue by $1 billion to $6.1 billion and EBITDA by $400 million to $1 billion.  The reduction stemmed mainly from continued weakness inBrazil, notably a weaker BRL, lower sub growth due to higher churn, and lower ARPU as competition has become increasingly promotional.  Management also highlighted the 3G WCDMA network upgrade costs, and further investment in marketing.  So after several years of high growth, the top line is moderating, showing declines in USD for the first time, while maintaining slight positive growth in local currencies.

As a result, sentiment couldn’t get much more bearish now with multiple sell side downgrade in the past six months, so that “holds” and “sells” now outnumber “buys.”  The stock has declined over 70% in the past year and the shares short are over 30% of outstanding. 

However, there is a light at the end of the tunnel.  After delays earlier in the year, NIHD is in the process of rolling out 3G in its major markets. Brazil, which was 51% of revenues in 2011, will launch 3G by yearend in Sao Paolo and in 2Q13 inRio de Janeiro.  NIHD launched 3G inMexico, which was 33% of revenue in 2011, during September with 40 million of 80 million iDen covered POPs, which will expand to 80% within 18 months and the remainder by the end of ’14.   PeruandChile, which contributed just over 5% of revenue in 2011, launched 3G in May, 2012.

There are numerous benefits to providing 3G.  Customers want access to the internet and faster data rates.  3G increases NIHD’ addressable market, which should increase net adds and reduce churn.  Data is a higher valued service sold on top of voice plans, which will drive ARPU higher, possibly by 10-20%.  Operating expenses are lower in 3G networks, by 10-15%.  3G will also lower the cost of handsets since WCDMA is an industry standard, so the greater scale will lower wholesale costs, and therefore subscriber acquisition costs.  It could also allow NIHD to provide better handset subsidies, driving net adds.  During the initial rollout phase though, 3G could reduce margin as there will initially be lower capacity utilization of the network and higher handset subsidies.  However, in general it means faster growth and higher profits.

Promotional activity from the big four inBrazil(Vivo, TIM, Claro, Oi) has continued to be heated.  NIHD is well positioned with small and medium sized businesses, but has not been immune to this broader pressure.  Therefore,Brazilwill remain challenging for the foreseeable future with high churn and ARPU pressure.  Management believes it is stabilizing in 2H12, but their record of forecasting is spotty, so it is more conservative to expect this to continue for some time, although three of the four main competitors are subsidiaries of European firms that are dealing with their own issues and deleveraging, so competition could stop chasing gross adds as much. 

Despite the competitive environment inBrazil, the market there has some positive attributes.  It is a vibrant economy where mobile data is thriving.  There are 256 million mobile accounts, of which roughly 60 million are smart phones or mini modems.  NIHD has delayed its 3G ramp, but with 3G roughly 20-30% penetrated, there is still ample room to pick up market share.  3g devices and data revenue growth rate are doing very well, so this should reinvigorate NIHD’s top line and margins.

Operations inMexicoare a bit better relative toBrazil.  NIHD has grown based on its competitive strength of a superior network and differentiated services.  Its 3G network is offering data speeds twice that of the competition, so it should maintain its position with the higher end consumer.  Coverage areas are less extensive than competition to start, but they cover the main metropolitan areas, which should be enough to start with given the population densities inMexico.  Also, AMX’s Telcel has been more focused on margins than gross adds, so competition has rationalized.

Argentina, which was 10% of revenue in 2011, has been a cash cow and currently there are no plans to upgrade to 3G.  It is not possible to expatriate cash from the country and NIHD has about $80 million stranded there for the time being.  There is potential for a network sharing deal or a complete exit of the market.

NIHD has 171.6 million shares outstanding and closed at $7.91 on 10/16/12 for a market cap of $1.36 billion.  It has $1.96 billion of cash and total debt of $4.61 billion, yielding an enterprise value of $4.01 billion.  It is trading at .6x $6.47 billion in revenue and 3.3x $1.23 billion of EBITDA LTM.  And .5x BV and .8x TBV.   This valuation is similar to where it traded during the credit crisis and a discount to global peers.  Alternatively, NIHD finished 2Q12 with 11.2 million subscribers, so the enterprise is being valued at $358/subscriber.  Macquarie estimates that the NPV of post paid NIHD subscribers inMexicoandBrazilare $634 and $990, respectively, which illustrates that NIHD subs could be worth a lot more to another operator that could earn a decent return on them.   

NIHD has no major maturities until 2015 and liquidity is strong with almost $2 billion of cash on the balance sheet with another $6-700 million in vendor financing available and the potential for asset divestitures.  Debt is priced in USD though, which can limit flexibility, given the location of the operating companies.  Net debt/EBITDA is 2.4x now, but could creep up toward 3.7x in 2013.

NIHD has frequently been the subject of M&A rumors and discussions, and in 2010 Televisa tried to acquire it.  It is often cited as a target due to its relatively small size, strong branding, position in the region, and the decline in equity value.  Integrating it into a stronger operator that could derive operating and commercial synergies and optimize its spectrum would make sense.   NIHD’s higher ARPU customers are also attractive to operators in developing markets that still rely heavily on prepaid users and have generally lower ARPU.  Management genuinely seems to believe in their own ability to turn the company around, but I think it would be worth much more in the hands or an operator benefiting from economies of scale.

A breakup of the company probably makes the most sense at this point.  Results should begin to improve with the ramp of 3G and competition becoming more rational over time, but NIHD will always have to contend with its lack of scale in its major markets.  Telefonica strategically would be a good fit, given the complementary overlap in footprint, but it has its own issues to deal with now and is also attempting to reduce leverage.  Reduced leverage at Telefonica could set the stage for M&A, but it is probably a less likely acquirer now.  There are other possible options though.  Vivo, a Telefonica subsidiary, inBrazilhas its own balance sheet that could raise local currency debt to do a deal.  AMX would like to improve its position inBrazil, although the regulatory environment inMexicowould most likely prevent acquiring assets there.  And it would make a lot of sense for the other smaller players inMexicoto continue to consolidate.  The sum of the parts to various acquirers definitely is worth more than continuing to operate as an also ran.

NIHD will most likely pursue a sale of its towers, which will provide some leeway with respect to increasing leverage and the capital requirements for building out its 3G networks.  Management believes that 7,000 of its almost 10,000 towers are marketable and have said that they would pursue divestiture if the economics made sense.  AMT and SBAC are the most obvious bidders.  There is quite a bit of variability in potential valuations for the towers, depending on location and the new operator’s ability to lease capacity to third parties.  However, there have been a good sample of tower transactions in the past few years, which suggest that NIHD’s marketable towers could be worth $150,000-300,000 per site, so gross proceeds of approximately $1 billion seem reasonable.  It is difficult to ascertain exactly what the tax consequences are and what new leasing terms might be, but this move would most likely be viewed very positively development, in relation to its market cap of $1.36 billion.  It would most likely be structured as a sale leaseback and could potentially be completed in the next six months if management were to start pursuing it.

In addition to towers, NIHD has valuable spectrum, although it is more problematic to sell piecemeal.  InBraziloperators are prohibited from selling spectrum without the license itself included.  In order to monetize spectrum inBrazil, NIHD would have to sell the right to offer services entirely, which management presumably would not be willing to do given their commitment to building out the new network and their apparent confidence in turning the company around.  However, there is a finite amount of spectrum and has real value in this highly competitive market. Brazilalso does have spectrum caps by region, so a potential acquirer would also factor that in.  Spectrum inMexicohas fewer restrictions and could be sold three years after its acquisition date, i.e. in October, 2013, and there are no cap limits.

CEO, Steven Dussek, bought 42,400 shares at $7 for a total of $297k in September, bringing his total holding up to 397,500 shares.  Other members of the management team also own significant amounts of stock, which should align their interest with shareholders, although obviously this has not prevented poor capital allocation and missteps in the past.

NIHD also just announced the hiring of a new CFO, Juan Figuereo, to replace Hemmady who became COO in June.  He previously was CFO of NWL and COT, and worked in M&A at WMT international.

The principal risk with NIHD is that operations continue to deteriorate, despite the investment in networks.  Perucould be a canary in the coal mine in this respect, since results have not picked up since the launch of 3G there, although it is only one quarter along so it is too early to extrapolate much.

There is still a lot of uncertainty about the next year and half at NIHD, which makes it difficult to model.  This quarter will again be weak (possibly providing a good entry point) and sell side estimates for 2013 will probably be reduced more.  There is no quick fix, so these challenges will persist a few more quarters and free cash flow will be negative through 2013, but as 3G rollouts progress operating metrics will improve, which in turn will lead to higher valuation.  At this valuation much of the bad news is already priced with asset value providing some margin of safety, and the potential for changes to capital allocation/M&A to create value and significant upside in the stock.

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