NextWave Wireless: The Most Leveraged Play on iPhone 3G

Includes: AAPL, WAVE
by: Anton Wahlman

One year ago, when the first iPhone hit the market, investors sought a highly leveraged derivative play as an alternative to buy the obvious Apple (NASDAQ:AAPL) stock. At that time, the answer appeared to be Synchronoss (NASDAQ:SNCR), which went from under $10 to $30 at the time of the iPhone launch, and $45 shortly thereafter. At that time, the driver was a new provisioning system, because the iPhone – just like the GSM-based Blackberries (RIMM) – was only equipped with an EDGE radio. Thanks to WiFi, this induced people to stay away from utilizing the slow cellular frequencies for web surfing, including mobile search.

This time around, the new iPhone 3G launching on July 11 will spur at least one other derivative play, and that's the bandwidth play. For the first time on a handheld, the iPhone 3G combines the standout handheld browser with an HSPA radio fast enough to yield a decent web browsing experience -- including mobile search – when you're not on WiFi.

The gigantic expected increase in wireless bandwidth demand has not been lost on the various carriers looking to be exposed to the iPhone 3G. Earlier this year, AT&T (NYSE:T) was one of the two major winners of the 700 MHz auction here in the U.S. This month, the bids for the Canadian AWS auction (1.7 and 2.1 GHz) were running approximately twice the price of the equivalent U.S. auction two years ago.

Let's analyze that for a moment. In August 2006, the U.S. carriers paid $0.54 per MHz POP for the AWS spectrum. Today, Rogers is Canada's dominant GSM carrier, and is among the bidders pushing these prices to a dollar or perhaps more. As they said during the cold war, there is no such thing as a coincidence – Rogers is expected to launch the iPhone 3G and expects to be in acute need to make way for this tsunami of bandwidth demand.

Of course, you may say, the initial version of the iPhone 3G doesn't contain 1.7 GHz capability. That's true, but if a carrier such as Rogers or AT&T acquires such spectrum, it can shift other users – such as laptop cards and other handhelds – into these frequencies, paving the way for more iPhone 3G bandwidth on the frequencies supported by the iPhone 3G.

T-Mobile USA is showing the initial impact and pathway for AT&T and Rogers in this regard. In the early stages of launching these AWS frequencies, T-Mobile USA has only a handful of handsets that are AWS capable, but many more handsets and laptop cards are expected before the end of 2008.

Take the Blackberry, for example. For the last four years, starting with the 7290 model, AT&T and T-Mobile USA have harmonized their Blackberry offerings in terms of the GSM bands (quad – 850, 900, 1800 and 1900 MHz). This harmony was maintained in the 8700, 8100, 8300 and 8800 series of GSM Blackberries. After four years, this harmony looks to break up within the next few months, because of T-Mobile USA's 1.7 and 2.1 GHz AWS network. Blackberries as well as other handsets will have to become six-band handsets (850, 900, 1700, 1800, 1900 and 2100 MHz), which would help Rogers and AT&T to go down the same AWS spectrum path, using the same handsets.

Why is this so important for NextWave (OTC:WAVE)? Because as AT&T faces an acute spectrum shortage with the iPhone 3G demand, it will need to do precisely what its iPhone3G sister North of the border is seeking to do right now – acquire as much AWS spectrum as possible. Just as Rogers needs to double the width of its spectrum freeway to make way for the iPhone 3G, so does AT&T. In this context, NextWave offers the most attractive – and fastest – way for AT&T to remedy its expected bandwidth crisis, with its 947 million MHz POPs of AWS spectrum. Using the 2006 U.S. price of $0.54 per MHz POP, this implies a $511m value. However, as the other carriers rush to save their iPhone 3G bacon, using the $1 or higher price paid in Canada in recent weeks, this implies a billion dollars of value. In addition, keep in mind that the U.S. spectrum typically would trade at a premium to the Canadian spectrum.

At the current stock price of approximately $4.15, WAVE stock implies a $423m market cap using 102m shares. Add $350m in debt and $375m in convertible debt and you have an enterprise value of about $1.15 billion. Amazing as it may sound, if WAVE sold only its 947 million MHz POPs worth of U.S. AWS spectrum for the $1 price in the current Canadian auction, it could retire all its debt (including the convertible) plus be left with $222m, enough to pay a $2 per share dividend if it should so desire. Obviously, WAVE would not pay such a dividend unless it also sold some or all of its WCS and 2.5/2.7 GHz spectrum, but it goes to show that the company seems to be shockingly undervalued at the current stock price.

In addition, what is the story at T-Mobile USA and its AWS spectrum depth? You may have seen its May 5 press release where it reads "By year's end, T-Mobile expects its high-speed data network will be available in those cities where a majority of its subscribers currently use data services." Yes, that "majority" is just that – not all of its markets, because in 30 out of T-Mobile USA's top 100 AWS markets, it has only 10 MHz worth of spectrum; clearly sub-par for launching acceptable 3G service. 20 MHz is considered a starting point for launching such services. One would believe it is in T-Mobile USA's interest to plug those 30 holes in its top 100 markets by purchasing these 10 MHz or greater properties from WAVE, as soon as possible this July 2008.

For these key reasons, it is reasonable to believe that WAVE is the most leveraged play on the iPhone 3G.

Disclosure: As of this writing, Anton Wahlman is an individual investor who owns WAVE stock.

Note: Anton Wahlman was a sell-side analyst from 1996 until 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.