Description

I am recommending buying shares of NII Holdings (NIHD), a niche wireless operator using the Motorola idem technology in Latin America, specifically Mexico, Brazil, Argentina, Peru & Chile.  NIHD was previously written up in 2002 by Charlie479, and has been down over 20% in the past week, and 50% in the past 6 months.

 

Currently, an attractive entry point into the stock has been created because of the confluence of several factors:  Extreme pessimism among the investor community regarding the competitive environment in NIHD’s main market, Mexico;  investments being made in Brazil and Chile including possible participation in the Brazilian spectrum auction next week; and technical factors including Fidelity selling down its massive position >10 million shares (filed 12/10).  Over the past 2 years, NIHD has appreciated significantly, mostly on the heels of many fast-money hedge funds, as the company became a darling of Wall Street.  Recently, this has changed.

 

NIHD has declined more than 50% from its July 19^th peak above $90, despite the continued growth of its differentiated product, increasing margins and FCF generation.  NIHD is currently trading at 5.9x 2008 EBITDA, while expecting a 5 year EBITDA CAGR of 34% and FCF CAGR through 2011 of 86%, making it the fastest growing Latin American telco, with one of the cheapest valuations.  Since July, as NIHD has declined 50%, while American Movil (AMX) is basically flat.  The stock, traded on the Nasdaq, and based in the US, has disconnected from other emerging market and Latin American stocks.  While NII has had some recent headwinds in the Mexican market, the growth has continued unabated as market expansion begins to reaccelerate growth in both Mexico and Brazil and the company hits the FCF inflection point towards the end of 2007.  Additionally, while the company did not give specific 2008 guidance, it did comment during the last conference call that 2008 net adds will surpass the record 2007 net adds (1.275 mm guidance). 

 

An overreaction in the market, combined with the above mentioned technical factors has allowed for investors to get in at this valuation.  This being said – I think technically through the end of December, continued loss and panic selling could put a lid on any stock rally, but over the next 6-12 months, I believe this stock will be between 50% and 100% higher than current levels.  My price target for NIHD is $85, or about 100% above current levels.  $85 represents 8.1x 2009 EBITDA.

 

 

Business Description. 

 

NII has wireless operations in Mexico, Brazil, Peru, Argentina and Chile using the proprietary Motorola iDEN technology.  Currently, the company covers 168 mm POPs, and operates in the top 5 cities in Latin America.  The company focuses on providing Small Businesses and Enterprises with a compelling and differentiated solution that includes both regular cellular service, push-to-talk and data services.  The company does not target the prepaid Latin American mass market, and a typical business customer could be security teams, car fleets, construction, roaming hotel employees etc.  In fact, many NII customers actually have a personal (non-business) phone from AMX or Telefonica also to make personal calls.

 

Throughout the past 3 years, the company has expanded its Mexican footprint by over 60% and now reaches more than 80% of GDP in Mexico.  It has also been expanding in Brazil and has recently announced a further extension of its covered POPs in Brazil to the 80% GDP level and an smaller expansion into Chile.  The company also provides iDEN roaming throughout the Western Hemisphere and allows for international push-to-talk. 

 

Penetration in Latin America is significantly below that of the US and Europe, around 50% currently.  NII’s competitive advantage entails only targeting a small subset of the marketplace, providing exceptional customer service to them, having a strong and motivated management team, and offering a differentiated product.  In addition, the company’s offering while superior for business customers, actually is priced at a discount to its competitors postpaid offerings.  AMX’s postpaid ARPU in Mexico is north of $90, while NIHD’s postpaid Mexican ARPU is $74.  This is mainly due to the efficiency and inexpensive nature of the PTT dispatch technology, thus allowing consumers to use more minutes for less.  The company in recent years has been accelerating its growth by expanding coverage throughout its markets, but according to their numbers still has only penetrated 10% of its addressable market (business & corporate postpaid), so significant growth still lies ahead.

 

As mentioned before, NII is clearly a niche player in the markets it operates, and does not go after the mass market pre-paid subscriber, which have typically very low ARPUs (<$20), instead targeting the post-paid customer, mostly business users.  The company will have 4.7mm subscribers by year-end 2007, which is growth of over 36% y/y.  The company is growing rapidly, with revenues projected to grow at a CAGR of 24% through 2011, EBITDA projected to grow over 30% in the same period, and FCF at 86%. 

 

NIHD has continually put up some of the best subscriber metrics in the wireless business – showing consolidated ARPU of $59 in Q3, up $1 y/y and q/q and churn of 1.6% / month which was flat q/q.  This compares with its large competitors – AMX, TEF which have average ARPUs of $15 and churn of 3.5%.  Customer acquisition payback has remained less than  6 months, while the average customer lifetime is more than 5 years, or an average Revenue over the life a customer of > $3,600.  The company continues to load up its expanded network, and with that it will see significantly expanding EBITDA margins.   Margins are expected to grow from 28% currently to over 40% by 2010. 

 

Mexico

As mentioned above, the Mexican market has become increasingly competitive, which is the primary reason for the opportunity to buy this stock at trough valuations.  The company now covers 80% of the GDP in the country, or about 64 mm POPs.  The Mexican segment has historically made up the majority of the Subscribers, Revenue and EBITDA base of the company – 45%, 57% and 69% respectively.  However, this is beginning to even out as growth in subscribers, revenues and EBITDA margin improvement in Brazil outpaces that of Mexico.  Despite the headwinds discussed above, the company still showed segment EBITDA growth of 42% over the same period last year and continues to take market share in the postpaid marketplace.  The company described the competitive environment as suffering from heavy promotions by its competitors, however not directed with a competitive PTT product.  They also commented that they have seen an improvement in the level of subscriber additions in September & October.  Going into 2008, it is important to note that the company has just completed its 3-year expansion of coverage in Mexico, increasing covered pops by 60% to 64 mm and 80% of GDP, and is now entering 2008 with its largest operating footprint to sell its product into.  NII, with less than 5% of overall Mexican market share continues to get more than 30% of post-paid net adds (actually 40% in 2007, but expecting less in 2008 b/c of the competitive dynamic)

 

To be fair, the Mexican market has become increasingly promotional and competitive as Telefonica has worked hard to take market share from American Movil, and AMX has refocused its attention on the postpaid market.  Net additions in Q3 2007, came in slightly below its record net addition number in Q2 2007, due to this increased competitive environment and also several hurricanes in that hit Mexico during the period.  The company did reiterate its 1.275 million net subscriber additions for the entire year, which would be a 37% increase in the year ending subscriber base.

 

 

Brazil

Brazil has shown tremendous growth over the past few quarters, with continuously improving metrics.  During Q3, the company saw 51% more net adds than the year before and 66% growth in segment EBITDA y/y.  Brazilian churn has continued to come down, and is now at 1.3%, the lowest in all of the company’s markets, as ARPU continued to increase as well.  The company has continued to expand its footprint in Brazil, and announced that it is investing an additional $300 million over the next 2-3 years to continue expanding the footprint, and bring the GDP coverage on par with other markets. 

 

Argentina, Peru & Chile – Argentina has continued to grow with continued margin expansion, showing revenue growth of 27% and EBITDA growth of 47%.  Peru also has shown outstanding subscriber growth, with 57% y/y sub additions y/y.  The company has recently moved from an experimental system in Chile to guiding towards a full buildout over the next few years.  They have pointed to $80 million of capex to do this. 

 

The company has an underlevered balance sheet with only $488 million of net debt (0.5x), providing ample liquidity for capex, spectrum and/or share buybacks.

 

NII Holdings
								2007-2011
	2006	2007	2008	2009	2010	2011		CAGR
Subscribers	3,440	4,690	6,040	7,350	8,550	9,650		19.8%
Sub Growth		36%	29%	22%	16%	13%
Net Adds		1250	1350	1310	1200	1100
Revenue	$     2,371	$     3,270	$     4,340	$     5,425	$     6,523	$     7,615		23.5%
Revenue Growth		37.9%	32.7%	25.0%	20.2%	16.7%
EBITDA	$       694	$       975	$     1,495	$     2,027	$     2,598	$     3,185		34.4%
EBITDA Margin	29.3%	29.8%	34.4%	37.4%	39.8%	41.8%
EBITDA Growth		40.5%	53.3%	35.6%	28.2%	22.6%
FCF	$      (138)	$       155	$       547	$       992	$     1,445	$     1,865		86.2%
FCF Growth		NM	252.9%	81.4%	45.7%	29.1%

 

Technology

Many investors and sellside analysts have documented the demise of the iDEN technology in the US, mainly due to Sprint’s botched acquisition of Nextel.  Many questions persist, with a new management team coming into Sprint what the future of iDEN at Sprint will be.  The reality is that there are over 30 million worldwide subscribers of this technology in 26 countries; Motorola continues to innovate both the infrastructure and innovative handsets to continue to support this technology, which is highly profitable to them.  In addition, the company recently signed an extension of its iDEN agreement with Motorola and Motorola continues to be committed to this platform until 2011.  So while technology migration is inevitable in the wireless industry, there is no impending doom of the end of iDEN in the next few years.

 

While upgrades to 3G technologies in the United States, Europe and other areas has been one of the key drivers of stable to increasing ARPU, this has not been the case in Latin America as of yet.  Major carriers (Telefonica, AMX) in Latin America have slowly been building their 3G spectrum portfolio and building out these next generation networks, however while they have begun the upgrade cycle, the immediacy and ROI has yet to materialize.  Unlike in more developed markets, demand has been driven more by higher efficiency for voice transmission and data has mostly been utilized for SMS messaging, which can be provided with NIHD’s current iDEN technology.  AMX, the leading Latin American operator has 15% of ARPU from data, however 12% of this is from SMS messaging.  According to DB, Argentina, the country with the highest data revenue as a % of ARPU at 27%, only 5% is from non-SMS services.  Much of this has to do with the later development of the Latin American market as well as cultural differences that exist. 

 

NIHD has the advantage and experience of watching how technology and customer acceptance evolves in the United States, and then taking best of  breed practices and implementing them in its markets.  The company should have several options available to it by the time it is ready to implement a 3G data solution, including overlaying its technology with 1xEVDO Rev A or UMTS technology on its existing network, or alternatively producing dual-mode handsets where data would be transmitted on another frequency.  Additionally, NIHD has acquired substantial WiMax and 3G spectrum in Mexico, Argentina and Peru which could potentially be used a 3G alternative.  Because of this, it should have come as no surprise when it was revealed yesterday that NIHD will be bidding on the Dec. 18^th Brazilian 3G auction for 1.9-2.1 Ghz frequency, however the stock sold off a further 5%.  The company has ample liquidity to fund such a spectrum acquisition if it sees fit. 

 

Other competitive PTT offerings

AMX and Telefonica both offer PTT offerings, however none are based upon a technology that allows for the same seamless, inexpensive, and low latency that NII does.  These products have historically been targeted at individual post-paid consumers, rather than businesses that have fleets (like NII).  AMX’s offering requires the user to sign up for a post-paid plan, then pay additional fees on top of that for PTT functionality, and because most AMX consumers do not have this feature, the network effect doesn’t push the demand strongly for the product.  Additionally, Telefonica’s offering is not really a true PTT offering as it does not operate with walkie-talkie functionality and is limited to using to only a small community of subscribers, not the general public.  Also, the benefit of iDEN is that it dedicates an entire frequency to PTT, and a separate channel to interconnect traffic, therefore not clogging the network with dispatch traffic.  CDMA and GSM networks of competitors do not do this, therefore disallowing the same quality of service. 

 

Valuation

NIHD is now trading at its lowest multiple in over 2 years, despite its excellent operational performance going into 2008.  Currently, the company is trading below 6x 2008 EBITDA, 4.4x 2009 EBITDA with a 2009 FCF yield of 12%.  Its main competitor, AMX which historically has traded at a discount to NIHD because of the relative growth profiles, is now trading a premium.  AMX is trading at 7.8x 2008 EBITDA and 6.8x 2009 EBITDA.   This is not a negative opinion of AMX, just looking at relative valuations.  Clearly, there has been a large divergence between operational reality and the current stock price for NIHD.

Current Share Price		$45.00
FD Shares		186.80
Market Cap		$  8,406.0
Net Debt		471.0
Enterprise Value		$  8,877.0

		NIHD		AMX
2007 EV/EBITDA		9.10x		10.03x
2008 EV/EBITDA		5.94x		7.82x
2009 EV/EBITDA		4.38x		6.80x
EBITDA Growth 2007-2009		44.2%		21.5%
2007 P/FCF		54.23x		20.56x
2008 P/FCF		15.37x		14.55x
2009 P/FCF		8.47x		12.15x
FCF Growth 2007-2009		153.0%		30.1%
2008 FCF Yield		1.8%		4.9%
2008 FCF Yield		6.5%		6.9%
2009 FCF Yield		11.8%		8.2%

 

Growth into 2008 and Catalysts

 

Mexico

·         The company is combating the competitive pressures in Mexico by introducing new plans, emphasizing cheaper dispatch minutes, while de-emphasizing interconnect minutes.  While this has the effect of slightly decreasing ARPU, it will ramp up margins because the costs associated with dispatch minutes are significantly lower. 

 

·         Calling Party Pays à The Mexican telecom regulator ruled that mobile carriers must interconnect w/ NIHD now that the company has a local trunking license.  This ruling and agreement allows for NIHD to introduce CPP and could drive up usage over time and is a positive to attract consumers who were hesitant to have an NII phone because of the risk of paying for all incoming calls from other mobile networks (most traffic is originated from AMX), which could drive up costs.  Additionally, over time, the company will begin to get interconnection revenue from the other carriers, which it has 0 of at this point.  Over the past two days, NIHD signed interconnection agreements with AMX and Iusacell.

 

·         SMS à Also because of the above mentioned interconnection w/ AMX and Iusacell, NIHD can now offer SMS from a NIHD phone to an AMX phone (something that wasn’t possible previously).  This is a huge opportunity in the long run, as 12% of AMX’s ARPU is SMS, and almost none of NIHD’s ARPU is SMS, mostly because AMX has 70+% Mexican market share.  If NIHD can even capture a small piece of the 12% AMX has, this will have a significant ARPU lift. 

 

 

·         The company guided that 2008 net adds in Mexico and Brazil will outpace net adds in 2007.  Given that addressable POPs in Mexico have increased 4 million in 2007 and combined with the network effect of the PTT product, the maturation of markets launched in 2006 and the incremental benefits of data products and especially SMS, NIHD should successfully mitigate marginal weakness caused by the competitive landscape in Mexico going forward.  The network effect is an important factor to consider when looking at the push-to-talk product, as network coverage is essential to get businesses with multiple locations around Mexico.  So while the company may have had service in Mexico City, and they pitched the business to a car service company there that also has operations in Tijuana (where they didn’t have service), this typically wouldn’t result in a sale.  But now, as the company has expanded network coverage into all metropolitan areas and over all major highways, they can go after this type of business in Mexico City, whereas they otherwise couldn’t. 

 

Brazil

·         Increased Brazilian footprint and sales distribution à Similar to Mexico, the company has expanded its coverage here, and will continue to do so over the next few years.  In addition, they have expanded their distribution force, both direct and indirect in Brazil, while further incentivizing them with higher commissions to ramp growth.  Both of these should lead to robust growth in 2008 and forward in subscriber growth, and then profitability.

 

General

·         EBITDA margin expansion and FCF generation à EBITDA margins should continue to expand in all markets, as more traffic is loaded on the network, therefore scaling the fixed cost network that has been put in place, and as the Mexican capex and market opening opex falls off.  In addition, NIHD has significant backhaul fiber in Mexico from its acquisition of Cosmofrequencias that it has been unable to use because of existing agreements with CLEC Axtel, which should end in 2008 and 2009.  Margins are expected to grow from the current consolidated level of 29%  to 40% by 2010.   FCF is expected to grow at an 86% CAGR over the next 5 years, presenting significant opportunities for growth, investment, or returns of capital to shareholders.  FCF generation began in 2007, and should continue to ramp into 2008 and beyond, moving from $155 million in 2007 to almost $1.5 billion by 2010.

 

·         Stock Buybacks à The company’s balance sheet is underlevered at .5x net debt / EBITDA.  They recently did a $500 mm convert, where they used ½ to buyback shares and then bought back another $80 mm in the open market prior to the Q3 call.  I would not be surprised if the full $500 mm authorization has been exhausted by now.  The investor community would reward any announcement of further share buybacks, and acknowledgement that the worst in Mexico could be over. 

 

·         Strong Q4 earnings and 2008 guidance or possible preannouncement of Q4 à Again, investors need to regain confidence, despite the cheap valuation of the company and this will be demonstrated during the Q4 call where they will first give details around 2008.

 

·         Change of Sentiment à This seems trivial – but given that we are at year end, and this is a highly concentrated hedge fund stock, beginning in January, much of the selling pressure, along with questions around Fidelity’s large sales will go away.

Catalyst

1) Change of investor sentiment; year/end selling abating, Fidelity selling 10mm shrs
2) Announcement of share buyback, and increased use of balance sheet
3) Strong 2008 guidance, possibly preannounced --> growth from previous network build in Mexico & Brazil offsetting increased competitive environment in Mexico
4) Stabilization of competitive environment in Mexico; continued strength in postpaid share in Mexico
5) Disciplined bidding on Brazilian spectrum auction
6) CPP, Interconnect and SMS revenues beginning to be valued and reflected in sellside models
7) Data revenue ramping as % of ARPU
8) Ramp of FCF into 2008 and beyond, growing at a CAGR in excess of 80%