NextWave Wireless: Spectrum Options for Other Operators

Is the value of NextWave Wireless (WAVE) greater than a stock price of approximately $6.00? 

At $6.00 per share, the market cap is, at a minimum, $618m
based on 103m shares. There is also a convertible redeemable preferred
share class, which is currently close to $375m including accumulated
interest.

This would convert at close to $11 per share, or 34m shares, yielding a total of 137m shares – implying an $822m current market cap.  We will discuss below the two alternatives in terms of their impact on the valuation.

There is also $350m in debt from 7% Senior Secured debt financing.  At the end of March, cash was $141m, but the company has the ability to draw additional monies if it desires to do so, for liquidity reasons. There is an additional $50 million of cash from the proceeds of 7% Senior Secured debt financing left in escrow that company can draw down on which will net out to $43 million of cash proceeds after financing fees are paid. Therefore, at $6/share, the enterprise value (market cap – cash + debt) is either:

$618m - $141m + $725m = $1,202m

or

$822m - $141m + $350m = $1,031m

The company has announced its intent to sell its spectrum assets, so let's start by looking at the value of these spectrum assets. 

First, the AWS spectrum (1.7 GHz and 2.1 GHz):

WAVE has 947m MHz-POPs of AWS spectrum.  In the August 2006 AWS auction, the price was $0.54 per MHz-POP on average. Many operators such as T-Mobile, AT&T (T), Verizon (VZ), Leap Wireless (LEAP) have just started to use this spectrum for 3G, or will do so soon. This spectrum will also fit nicely with migrations to LTE in a few years.  AT&T and others have announced their intentions to use this spectrum for their 4G roll-outs. Leading contenders for NextWave’s AWS spectrum are obviously Verizon, AT&T and T-Mobile – but also Leap and MetroPCS.

Has the value of this spectrum gone up or down since August 2006? It's hard to say, but the importance of this general type of wireless property seems to be going up by the year – witness the iPhone, the continued success of the Blackberry and 3G services for laptops.  Nevertheless, let's assume the value of this spectrum has remained flat, and that WAVE owns "nationwide average" geographies.  If this is so, the valuation would be 947m MHz-POPs x $0.54, or $511m. The applicability of this average price seems to be justifiable because many of the 947m MHz-POPs are in the average or better than average markets. It is also the only remaining large and unencumbered strategic AWS footprint left in the country.

Second, the WCS spectrum (2.3 GHz):

WAVE has 2,807m MHz-POPs of WCS spectrum.  The other major holder of this spectrum is AT&T, which owns approximately half the MHz-POPs in the country.  AT&T launched services in a few places in the former BellSouth territory in 2004-07 using Navini pre-WiMAX equipment.  Cisco announced the acquisition of Navini in October 2007, an event which this author predicted in a September 2007 report.  This spectrum could be an important tool for AT&T to respond to Verizon's recent acquisition of the nationwide 700 MHz C-block providing for a nationwide LTE roll-out based on a 2x10 MHz profile.  One could argue that AT&T would be very compelled to buy either the AWS spectrum or the WCS spectrum – or both – in order to compete against Verizon’s future LTE technology.  Stated differently, one could argue that WAVE’s WCS spectrum is the only viable opportunity for AT&T to provide for a 2x10 MHz LTE roll-out nationwide; otherwise AT&T’s service offering may not be competitive with those of Verizon or Clearwire’s WiMAX offering based on a 10 MHz profile.

This 2.3 GHz spectrum could also fit entities seeking to use it for new mobile video applications, such as cable TV operators and satellite TV operators. Beacuse this is the only uncommitted near-nationwide spectrum and given that it is adjacent to AWS downlink frequencies at 2.1 GHz, it would be an ideal spectrum for mobile broadcast applications, such as an overlay network to a nationwide AWS network. With Comcast, Time Warner Cable and Google becoming major shareholders of Clearwire, a major marriage between mobile and content industries is now being consummated. This was a game-changing event that has created much talk among other players in mobile, broadcast and content industries. There are now several mobile TV technologies, including those from WAVE, that enable one’s mobile device become a personal TV with almost unlimited access to live and on-demand content. Those cable TV and satellite TV companies intending to partner with mobile network operators or complement AT&T’s 2.3 GHz spectrum would have a strong reason to acquire this spectrum with a notion to consummate their own marriage for mobile TV applications once AT&T or others start planning the roll-out of their LTE and/or WiMax networks. More importantly, under the current FCC rules, from both technical and regulatory perspectives there are no limitations on the applicability of the 2.3 GHz WCS spectrum to broadcast applications.

From a valuation standpoint, the characteristics of the WCS spectrum are close to the 2.5-2.7 GHz WiMAX spectrum ("BRS/EBS"), and indeed much of the WiMAX equipment – chips as well as systems – is built to support 2.3 GHz as well as 2.5-2.7 GHz.  The Korean WiMAX-like network, called WiBro, which is the largest de-facto WiMAX roll-out in the world, is at 2.3 GHz. 3GPP standards have also specified 2.3 GHz as a frequency band for LTE. The recent Sprint/Clearwire deal valued their spectrum at $0.28 per MHz-POP, which was considered surprisingly cheap; hence the fall in CLWR shares subsequently.  It is probably fair to believe that the WCS spectrum should trade at some form of a discount to the 2.5-2.7 GHz WiMAX spectrum.  On the other hand, WAVE owns its spectrum outright whereas a significant portion of CLWR’s spectrum, that was valued at $0.28 per MHZ-POP, is leased.  As a result, it may be fair to assume that the $0.28 price is a good assumption for this spectrum.  Therefore, at $0.28 per MHz-POP, it implies a value of $786m for NextWave’s WCS spectrum. It is also interesting to note that Qualcomm paid an average of $1.36 per MHz-POP for their five E-block licenses in the recent 700 MHz auction, property which Qualcomm intends to use primarily for its mobile TV broadcast application. It is also well known that 700 MHz spectrum has much better propagation characteristics than 2.3 GHz but at the same time, given the significant propagation distances covered at UHF frequencies, 700 MHz is capacity limited and substantially inferior to 2.3 GHz in its ability to deliver significant amount of content to future 4G networks, especially if such an application is intended for use in combination with 4G services in the AWS band or other bands in the 2 GHz-2.7 GHz frequencies.

Third, the 2.5-2.7 GHzWiMAX spectrum:

WAVE has 972m MHz-POPs in this band. 536m MHz-POPs are in the greater New York City area and 436m MHz-POPs are located elsewhere in the country.  NYC has historically carried a huge premium over the other big cities, let alone the nationwide average.  This isn't too different from real estate prices: Compare the price of that one-bedroom apartment in Chicago versus a similar apartment in Manhattan; it wouldn't be surprising to see a 2x+ difference. The historical prices paid for NY licenses in the PCS, AWS and 700 MHz auctions readily demonstrate this fact. Therefore, it seems fair to assign a value of 2.5x the $0.28 price paid by Clearwire, or $0.70 per MHz POP, to the New York area properties. Multiply that $0.70 price by 536m and you have $375m.  As for the other 436 MHz POPs, there is a debate about the value.  Some would simply apply the $0.28 Sprint/Clearwire average, but one could also argue that those other non-NYC cities are also well above the nationwide average, such as Los Angeles, Dallas, Philadelphia, San Francisco and Las Vegas.  We believe that it is reasonable to apply a 50% premium to the nationwide average for this spectrum, yielding a price of $0.42, or $183m in total.

To summarize NextWave’s domestic US spectrum values:

What about taxes?  This spectrum is carried on the books for close to $500m, and there is another $500m or so of NOLs, meaning the pretax profit base is perhaps close to $855m.  At a 40% tax rate, that would mean $342m in taxes.  In many of these kinds of situations, some tax deferral or sheltering can be common, yielding a lower effective tax number.  However, the more conservative estimate means after tax proceeds from spectrum sales would be $1,855m minus $342m, or $1,513m.

Of course, this isn't the whole story.  WAVE also has other assets, such as chips, systems and software.  The valuation of these businesses is a lot trickier than the spectrum, in many ways.  Several of these product lines have yet to start shipping in high volume, yet others can be assumed to be profitable, and finally these divergent assets are bundled together into the same company, implying a conglomerate discount.  The chip business clearly hasn't hit volume yet, but it is believed that the WiMAX market could hit 100m client units per year in a few years from now, plus more lucrative base station business.  Just for the sake of making a conservative assumption, if WAVE captures 5% of this market, or 5m units, at perhaps $5 apiece. That's $25m/year.  WiFi and WiMAX pico and micro base station and other chip revenue could be equal, based on much lower volume but at much higher prices, so that would imply $50m in revenue a couple of years down the road.  Today, such a property could trade for close to 2x such forward revenue, or $100m. It may be a stretch today, but over time it would work.  Of particular note regarding WAVE’s chip business, is that it seeks to combine WiFi and WiMax into the same chip, and it may be the first company to achieve this milestone.

The systems level business contains a bewildering array of standards-based equipment, from WiMAX to LTE and other technologies. WAVE's successes at T-Mobile Czech Republic and with the NYC public safety network are becoming legendary.  This business could be on track to hit $100m this year, and it could be worth close to 2x its 2008 revenue, or $200m.  However, as part of a conglomerate and with a cash burn attached to the conglomerate, today's implied imputed value is probably closer to $100m.

The software business is the most exciting of the technology businesses, with its strong positions at Verizon, NTT DoCoMo, Orange and in Google's Android.  The PVConnect software is embedded in market-leading router vendor products for in-home multimedia distribution, access and management.  This business could end 2008 at an $80m annualized run-rate, which as a stand-alone business could yield a 4x multiple, or $320m value.  However, given this business' status as a conglomerate constituent part, which is making losses overall, it would imply something a lot closer to $100m in value today.  Let's split the difference at $200m. If the announced TDtv commercial pilot in London with Orange and T-Mobile later this year proves to be successful, then the synergies between WAVE’s chipset, which would be embedded in 3G handsets, network equipment, with WAVE’s TDtv transmitters deployed as an add-on to the existing 3G BTSs, and PacketVideo’s software, supporting both mobile clients and back-end systems, would become more obvious. This clear example of synergies between seemingly disparate businesses of WAVE could reduce the conglomorate discount applied to its businesses.

The bottom line on the technology assets is therefore a $400m valuation today, which would probably be a lot higher were it not for the current cash burn and the conglomerate discount.  Expenses for these businesses are approximately $55m per quarter, including annual bonuses.  Offsetting these expenses is the gross margin contribution of the revenue, or a number rapidly approaching $20m per quarter.  That means a $35m per quarter pro forma net cash burn on average this year.  Based on this metric, WAVE can easily fund its operations through 1Q09 without any dramatic balance sheet maneuvers.

Given the $1.855bn expected pre-tax sales of spectrum, which one has to believe would occur well before 2008 is over, all of these liquidity concerns should soon be over.  The key here is of course that WAVE needs to sell at least SOME of its spectrum before 1Q09.  It is hard to see how WAVE would fail to monetize at least some share of the $1.855bn expected pre-tax proceeds, as soon as possible.

Finally, on the liquidity front, WAVE's management owns a significant portion of the company and one can believe that it would not put itself in a position to jeopardize the company's liquidity.

Summarizing the valuation, here would be the table:

Depending on whether one uses $103m shares (without conversion at $11) or $137m (with conversion), you would either subtract $725m in debt or $350m in debt, so arrive at shareholder value.  At $2.013bn of asset value, $725m debt and 103m shares, that boils down to $12.50 per share.  Using the same $2.013bn of asset value, but $350m debt and 137m shares, that boils down to $12.14 per share.  To those numbers, you would have to add the cash value; recently $141m but dwindling as a result of the burn.

In conclusion, one thought has been puzzling my mind recently.  Let’s say you’re AT&T and you want the AWS spectrum and the half of the country’s WCS spectrum you don’t already own, in order to launch LTE and mobile video offerings.  Based on the calculation above, those two properties alone may carry a value of $1,297m, which is some 50% over WAVE’s entire market cap, and greater than WAVE’s enterprise value.  If you are AT&T, and you want those properties, why not just go ahead and acquire all of WAVE outright, for a price that perhaps would not be too much different?  Then you can go ahead and spin off the chip, systems and software businesses for hundreds of millions of dollars, plus you would have $558m worth of 2.5-2.7 GHz of spectrum, as per the calculation above, which could be re-sold to Sprint/Clearwire unless AT&T wanted to keep it anyway.  This scenario would also likely be a more tax-efficient one than WAVE monetizing all of its spectrum assets in an item-by-item auction.

Disclosure:  As of this writing, AntonWahlman is an individual investor who owns WAVE stock. Anton Wahlman was a sell-side analyst from 1996 until early May 2008, first at UBS, then at Needham & Company and most recently at ThinkPanmure.  The numbers cited in this analysis are in many cases rounded, so please allow for some "back-of-the-envelope" discrepancies.

Comments

[msteele999:]

Glad to see someone is finally 'getting it' about NextWave!

2008 Jun 02 10:11 AM

[HedgefundIn...:]

Nice to see that SeekingAlpha finally got it right. Wahlman is a blue chip telecom analyst and it's a pleasure to read his well-reasoned analysis.

2008 Jun 02 10:51 AM

[RF:]

Great piece. Look forward to watching WAVE rise.

2008 Jun 02 11:42 AM

[joker:]

It is way too optimistic! The value of those spectrum is in the eye of beholder / belivers, just like the value of houses - a year ago's houses could fetch $1 million and now sitting in markets with a tag 25% down and still now takers!

So if now buyer really have to buy those spectrum immediately, WAVE will be in BIG trouble and face bankruptcy. And potential buyer, knowing the fate of WAVE, could simply wait for couple of years and after WAVE belly up, then scoop their needed spectrums cheaply.

2008 Jun 02 02:34 PM

[fury allecto:]

Too high by at least a factor of three on the spectrum.
1) WAVE's AWS assets are in tier 3 and 4 markets; their biggest licenses are Puerto Rico and Pittsburg (and you could find this data yourself - it's on the FCC website under auction 66; WAVE bought in the name of "AWS Wireless"). They bought the stuff for about 13 cents PMP - it may be worth 20 cents today.
2) WCS is beset with DARS interference and there is only one likely buyer, AT&T. WCS is worth maybe 10-15 cents PMP at best.
3) WAVE doesn't have a billion MHz POPs of 2.5 spectrum - it's more like 250 million, and almost all of it is leased, not owned. Sure, it's in good markets, but because of how 2.5 is licensed, it only covers slices of the geograhpy of those markets. There's also only one buyer (Clearwire/Sprint) and your valuation above doesn't back out the DCF of the leases Nextwave is obligated to pay the licensed holders. WAVE will be lucky to net 20 cents PMP for these leases.

2008 Jun 02 10:57 PM