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January 05, 2007

NII Holdings: New Buy Provides Unique Exposure To Emerging Markets Wireless

One of my favorite presentations at December's UBS Media & Communications Conference was from NII Holdings (NIHD). NIHD offers wireless telephone service using Nextel's iDEN standard in Mexico, Brazil, Argentina, and Peru. NIHD has approximately 3.2 million subscribers, primarily serving the business market.

I was interested in buying NIHD as soon as I returned from the conference in early December but the shares spiked higher following the company's well received presentation. The stock finally pulled back to an attractive point the first week of 2007 so I initiated a position across the entire Northlake client base.

Upside Potential Is Significant

NIHD shares trade at a well-deserved premium to other emerging markets wireless service providers due to the company's rapid growth and superior operating metrics in ARPU and churn. Margins are set to expand sharply after a multi-year period of investment to expand the reach of the network wraps up in 2007. At the UBS conference management was very confident that operating results were set to accelerate from already high growth levels. I think this can drive the shares to the high end of their historical valuation range, producing a stock price near $90 on 2007 estimates and $110 on 2008 estimates, or upside of 32% to 62%. I think that kind of upside provides plenty of compensation for the above average risk of operating in emerging markets (the risk is much greater to the stock price than the operating results as a review of the chart during last May's emerging market meltdown indicates)…

Company Overview and Stock Drivers

Almost half of NIHD's 3.2 million subs are in Mexico as is almost 70% of EBITDA. Brazil and Argentina are the next two biggest markets, with Brazil poised to grow more rapidly and move firmly into the #2 position. Peru is a smaller market offering solid growth prospects and good operating statistics. The company has recently announced expansion into Chile.

NIHD is much smaller than other wireless service providers operating in its markets because the company does not target the consumer market. NIHD should be viewed as a niche player due to its focus on business customers attracted by Nextel's proven push-to-talk technology. Wireless penetration rates in NIHD's markets still have plenty of room to grow providing a nice tailwind for the company's growth profile. Furthermore, as the company expands the geographic reach of its network, its target market outgrows the wireless market in each country in which it operates.

Rapid potential growth in NIHD's subscriber base is accompanied by the likelihood of sharply increasing margins. NIHD's margins have remained stable for the last several years as the company has incurred substantial expenses to expand its networks. This process is winding down in the first half of 2007. In addition to less investment spending, the company should begin to see the operating leverage normally associated with network based businesses. Finally, analysts are expecting lower interconnection rates to drive margins and traffic.

NIHD has a very strong financial profile. Consensus EBITDA for 2007 is around $1.1 billion, while 3Q06 net debt was just $550 million. The financial condition is going to grow even stronger as starting in 2007, NIHD should begin to produce significant free cash flow of over $100 million. If long-term growth estimates are reached, free cash flow could approach $1 billion annually within 5 years.

Growth Profile and Stock Valuation

NIHD expects to sustain its 30%+ 3 year CAGR of subscriber growth, revenue, and EBITDA over the next couple of years. Very rapid growth and financial strength has not been lost on investors with NIHD shares up over 50% in 2006. The shares trade at almost twice the EBITDA multiple of other emerging market wireless operators but this has been the case for many years. Investors are rightly paying up for the combination of rapid growth, U.S. style ARPU, and low churn.

With operating results poised to accelerate in 2007 off already high levels, I think the shares can sustain their valuation premium relative to comparable wireless stocks and trade at recent levels of 12-13 times current year EBITDA. Based on 2007 and 2008 estimates, this provides upside to $90-110.

Risks

As with any company focused on emerging markets, risks are high. NIHD faces additional risks because it uses a unique technology that is currently without a path to next generation technology. In September, NIHD signed a supply agreement with Motorola (MOT) extending through 2011, so access to iDEN technology is not a near-term risk. Nevertheless, this is a risk worth monitoring, especially as other operators perfect better push-to-talk technologies on industry standard technology.

Another risk for NIHD is that the company will use its financial strength to expand its footprint to new markets or new wireless technologies. These investments could be dilutive to current shareholder value.

Finally, Sprint Nextel (S) still owns almost 8% of NHID shares. The ownership has dropped sharply since 2002 when it was about 36%. Recent appreciation in the shares could lead Sprint to sell their remaining holdings creating added supply that might depress the NIHD shares.

I think the extremely high visibility of growth for 2007 and 2008 and the substantial upside that comes with it more than compensates for these risks.

Posted by Steve Birenberg at January 5, 2007 04:23 PM in NIHD