I write this in response to the several long theses produced on NII Holdings Inc. (NIHD) over the last few months, several of which appear compelling, at least, on their surface. The crux of my short thesis is that the economics of the business, predominately the historical pricing and margins they have enjoyed, are no longer sustainable. In short, their markets have moved forward and NIHD's profitability per sub is in the midst of declining dramatically. With the exception of the saving grace of an acquisition, I believe the likeliest scenario is a < $2.00 stock based on my 2014 EBITDA of roughly $700 mm - this is a rosy scenario for the business.
Let us first consider the historical context of NIHD. Up to 2011, NIHD was a growth stock. They carved out a niche in LatAM by offering a proprietary technology, push to talk or two-way radio, to heavy minute and corporate consumers on a post-paid basis. NIHD's value proposition was successful while competitors operated on other 2G equivalent platforms and offered predominantly prepaid offerings with limited minutes. Over the last two years NIHD's competitors have transitioned to 3G platforms and have begun competing head to head on post-paid unlimited minute plans. In response, NIHD is in the process of migrating to its own 3G network.
The following four points comprise a short thesis on the stock.
1) The traditional offering of legacy push-to-talk technology is facing direct competition from smartphones on other 3G networks - let me draw your attention to the success of Nextel's iDen network in the US, which went from a peak of 18 mm subs to less than 11 mm in 2012. Competitors are offering 3G technology with a wide assortment of smartphones to compete with NIHD's limited offering of push-to-talk handsets which is putting pressure on NIHD's subscriber base. It is important to note that NIHD only intends to offer 3G in "select" cities in Brazil and Mexico in 2Q/13 while several competitors expect to offer 4G by the end of 2013. NIHD is a full generation behind the market and handset offerings are decidedly behind the market.
2) NIHD's most important market is Brazil which is unfortunately brutally competitive. The market is 125%+ penetrated and while the four largest operators each control about 20%+ market share, NIHD possesses less than 2%. This is an industry where scale is critically important and NIHD has none. Mexico, NIHD's second most important market, is more attractive than Brazil but nevertheless remains very competitive and is also plagued by declining pricing.
3) Most importantly - NIHD's ARPU in both Brazil and Mexico is about 20-30% above those of its competitors (based on competitor ARPUs adjusted for pre-paid / post-paid mix). NIHD's gross margins per sub are 56% (as of 3Q/12). Contrast that margin with those of their scaled competitors who earn below 50% gross margins and one instantly wonders how NIHD will be able to grow, let alone maintain subs, without aggressively cutting ARPU and margins. I believe both ARPU and margin dollars per sub will have to decline by at least 20% for NIHD to compete and maintain its subscriber base. I encourage potential buyers to look, in close detail, at NIHD's margins over the last 12 months. You'll notice price declines (in local FX) and increasing CPGA with sub growth which has failed to compensate for the deteriorating margins. How has NIHD attracted subs in the past year? By lowering pricing and boosting handset subsidies dramatically! Look at the ratio of CPGA / ARPU, it has increased in Brazil and Mexico since 3Q/11 and it's worse over a longer time period.
4) Lastly - and most obviously - NIHD is burning cash at an alarming rate. Although liquidity will not be of concern until 2015 at earliest, the business burned about $1 billion in 2012, expects to burn $800 mm in 2013 and will not be cash flow neutral until at least 2015. As a consequence, Net debt / EBITDA will exceed 5.3x in 2013 (that alone is a rich multiple for LatAM telcos). NIHD also employs operating leases to finance a portion of capex (25-33%, depending on the period) and when including this, leverage exceeds 6.0x 2013 EBITDAR - be sure to look at their cumulative accrued and unpaid capex, i.e. op leases in their 10-k notes. The current process for a sale and lease back of towers is a prudent strategy to generate additional liquidity but that nevertheless increases off balance sheet leverage. Liquidity is sufficient for this business, but growing net debt is eroding equity value.
My argument is simply that NIHD's prior economic model no longer applies going forward. Its moat has been bridged! Yes, it trades below book value. There are two reasons why a business trades below book, this situation is one of them...it will not, can not, earn the same returns it once did. It is disadvantaged on scale, prices are 20-30% above market, and its technology is one generation behind. How does this business return to growth without cutting pricing?
I would be remiss if I did not address the fallacies of my argument. The first, and so vigorously put forth by previous authors, is the possibility of a Lancelot, a white knight. An acquisition of NIHD is certainly possible but to those long and hoping for one, be aware that Brazilian telecoms are at their spectrum limit and are unlikely to be permitted to acquire NIHD while DTV, without spectrum, has eyes for GVT. Note that NIHD's bid for Unicel, spectrum possessor in Sao Paolo, was blocked by Anatel, the Brazilian regulator, in December. Most domestic telecom operators are also highly levered (directly or through their parent) and, to my knowledge, have not expressed interest in acquiring NIHD. They most likely find it perfectly satisfactory to steal subs rather than pay a premium for a telco in the midst of a costly and uncertain technological transition. Potential Mexican acquisitors are not much different with the exception of perhaps Televisa who may be willing to acquire for the market share.
The second fallacy is of course that the turnaround may be successful and grow EBITDA beyond 2013. This is also possible but consider Nextel's experience in the US and the opinion of a hypothetical objective individual cognizant of the facts and you will likely conclude that it is a less than likely scenario. A resurgence of subscribers may be attainable, but most likely only at the expense of pricing and EBITDA. There may be something divine about push-to-talk which appeals to the LatAM market and implores consumers to pay a 30%+premium for it. As an atheist, I am not a believer.