NII Holdings - There Is No Turnaround, Sell While You Can

| About: NII Holdings, (NIHD)

I will try here to be very brief on the reasons why I think NII Holdings (NASDAQ:NIHD) or just Nextel is a short at the current price of US $8.

But, before I go through the rationale for the investment case, let me just say some words about the tower sales, something that has been getting a lot of attention lately. Make no mistakes, this is not a company that has a short-term liquidity issue that can be fixed via the sale of assets, its problems are much more structural. No matter how much capital it gets from selling its towers, it does not change the business model, it is just additional funding. By the way it is very expensive funding, as it sells these towers just to lease them back at a 10% rate. Compare this to the 3 to 4% rent that Oi (another very levered telecom company based in Brazil) pays in a very similar operation. Think about why Nextel is getting such a bad deal.

I also recommend whoever is long in this stock to check with real customers in Brazil and in Mexico what happened to the Nextel brand in their countries. Go to any upscale mall in São Paulo and ask around: Do you know anybody who used to have a Nextel handset? The answer will most likely be yes. Then ask how many of those people still subscribe to Nextel services. The number will range from 0 to 20%.

So you will ask me how come its client base in Brazil fell only 8% from its peak? Well, just look at average revenue per user (ARPU) and margins. ARPU is down 14% from its peak two years ago and EBITDA margin is down from 34% to 23% in the same period. Basically what is happening is that Nextel is subsidizing handsets and giving discounts to keep ever lower profitable users.

Telecom is a capital intensive industry. Look around and you can see that in any market it is the two largest players that capture over 70% of the profits. How can a company with less than 10% market share expect to make enough cash to finance a debt that has already reached 5 times its EBITDA?

So much for the introduction, let's go to the case. In order to do so we should answer the following four questions:

1 - How did Nextel become so popular in Latin America?

2 - Why is it not attractive anymore?

3 - What is it doing to recover?

4 - Why do I think its strategy will not work?

1 - How did Nextel become so popular in Latin America?

Nextel managed to become an aspirational brand in Latin America. It marketed itself as the best customer service in the industry, which it had for a while. It did have the lowest abandon rate among call centers of telecom operators. More important however, until 2009 it was the only company offering unlimited voice time in Brazil for both local and long distance calls within its network.

The social effect did the rest of the job. You wanted to be part of the network because your family and friends were already there benefiting from unlimited time to speak to each other.

2 - Why are its services not attractive anymore?

Basically for two reasons: unlimited calling became a commodity and Nextel's technology does not support data services.

Since Nextel launched its unlimited voice plans, every operator has followed suit. Competition is fierce in Brazil, as market operators are offering for US $15 the same product Nextel charges US $50 a month.

Its 2G network does not support data and its handsets look increasingly like antiques. It used to be common place in Brazil to see a Nextel client carrying both a Nextel handset for the radio service and an iPhone for everything else.

3 - What is it doing to recover?

In order to close its technological gap, Nextel decided to go for a new 3G network in Brazil and in Mexico that will allow it to offer data services.

4 - Why do I think its strategy will not work?

Even after it completes its investment cycle, Nextel will still be one generation behind. At the same time that it is starting to launch its 3G service, two competitors are marketing their 4G services. In the end it will be a VERY levered company reaching a Net Debt that is around 7 times its EBITDA in the end of this year with a product that is second best competing with companies that are many times its size.

Also, the push to talk Radio service is not a differentiating factor anymore. Competition in Brazil already has it. It is may not be as good as Nextel's but it is nationwide and it is getting traction.

It has already been six months since the launch of 3G in Mexico and operating metrics are still worsening, margins are at their lower levels, and ARPUs are still falling. You just need to go to a Nextel shop or visit its website and compare to what competition is offering there to see why. Handsets assortment is limited to say the least (no iPhones or Galaxies to start with) and 3G offerings that are just a little worse than those from the competition.

NIHD is burning cash at US$ 350 mm per quarter and it should keep burning. 3G licenses in Brazil are nationwide and there are minimum coverage requirements. Expenses will increase also as Nextel is going from operating a voice only network covering only the main metropolitan areas to a nationwide 3G network. That means at least twice as many towers and a lot of fiber capacity to lease.

Besides, it does not seem that the company is being transparent about its US$ 500 mm cash burn in 1Q13. Have a look at a transcript taken from the 1Q13 conference call:

Andre Baggio - JPMorgan - Analyst

Why the net debt increased $500 million from fourth to first quarter?

Juan Figuereo - NIHD - CFO

That's because we issued $750 million in new bonds in the quarter, Andre.

Andre Baggio - JPMorgan - Analyst

Yes, but that does not affect net debt, I guess

Juan Figuereo - NIHD - CFO

That increases debt and then we spend money, which reduces cash.

Andre Baggio - JPMorgan - Analyst

I will go over it afterwards. Thank you.

Summing up, I see no equity value for NIHD as it seems very unlikely that it will start generating cash again. Due to its lack of scale (half the size of the smallest competitor in Brazil) and huge leverage (Net Debt / EBITDA reaching 8x by the end of the year) it would have to charge a very high premium from its current and future clients to be cash flow positive. I simply don't think that this is a realistic assumption considering it is selling a service that is worse than what is offered by the competition. I don't see people in Brazil or in Mexico excited to pay more for 3G services that only works in second tier handsets just because it carries the Nextel brand and has a radio service that you can get for free with an app in any smartphone.

Disclosure: I am short NIHD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.