Bear Stearns bullish on all Nextel paper, for outrights and swap investors

By Ronda Fears

Nashville, Tenn., July 30 - Bear Stearns & Co. convertible analysts were bullish on Nextel Communications Inc. before its recent earnings announcement and are more so afterward. The group sees a great entry point for exposure in the wireless sector for outright buyers and hedge or swap investors.

For outright accounts, the group recommends the 6% convertible due 2011 and 4.75% convertible due 2007. Both have a market hedge of 25% and are senior notes.

For hedge investors, the group suggests buying the 9.375% high-yield notes due 2009 while shorting the 4.75% convertible due 2007 or the 5.25% convertible due 2010. Also, they note there is a variation for swap investors to duration trade the junk bond against the convertible and have a 25% long hedge on the common.

"While we were bullish on the Nextel bonds going into the earnings call, we feel that the Nextel 6.00% and the 4.75% convertible senior notes offer an even more compelling value to the credit savvy investors, who desire exposure to one of the stronger names in the wireless sector," said group head Rao Aisola in a report Tuesday.

"All investments clear investors' risk appetite at some price and we think Nextel 6.00% and 4.75% senior notes offer attractive risk reward at current levels. We rate the [Nextel convertible] notes attractive and recommend an overweight position" for outright investors.

For swap investors, he suggests buying the 9.375% straight bonds, which are trading at 18.57% yield-to-maturity at an indicated price of 64, and shorting the 4.75% convertible notes, which are closer in dollar price to the straights. Both are senior debt and rank pari passu with each other. However, given market volatility and a dynamic borrow situation, he said the 5.25% convertible senior notes are also a candidate for short against the straights.

He noted that a variation on the pairs trade is to duration trade the high yield against the convertible, and have a 25% long hedge on the common. While the long 25% hedge protects the upside, it enhances downside participation, he said.

Bear Stearns' high yield research group rated the 9.375% high yield bonds as attractive with an overweight recommendation when the bonds were at 69 with a yield-to-worst of 16.9%.

Last week, Nextel announced blowout second quarter results, Aisola noted, with EBITDA for the quarter of $816 million, "substantially above our estimates of $593 million and other estimates on the street." Further, Nextel management guided 2002 EBITDA up to $3 billion from $2.5 billion.

Afterward, Bear Stearns hosted an investor lunch with Nextel management to throw some light on the quarter's performance, he said.

Key performance metrics in the quarter that were discussed included the reduced capex without network starvation, lower equipment cost of $86 million due to lower rebates and churn of 2.1% and average revenue per unit of $71, both better than street estimates. Also noted were cost-per-gross-add declining to $440 from $460, versus the target of $400, and fewer pricing plans as the company collapsed thousands of pricing plans down to 38 by outsourced billing to Amdocs Ltd.

Further, there were strong seasonally driven top line results that contributed to an expanding 37.9% EBITDA margin.

"While seasonality may have contributed to these stellar metrics, we believe that outsourcing, consolidation of rate plans and solid execution played an equally important role," the analyst said in the report.

Going forward, capex for 2002 is expected to come under $2 billion and at $2 billion in 2003.

Bear Stearns added the 6% due 2011 to its convertible focus list at the beginning of June, at a price of 49. Subsequently, the notes sold off on general credit concerns to the 43 level and then after the bullish earnings traded up to 69. The issue has since settled at 57.5 on profit taking.

"We believe that these notes offer compelling entry point at current levels with a current yield of 10.43% and a YTM of 14.76%," Aisola said.

"We also like the Nextel 4.75% convertible senior notes due 2007, which are indicated at 58.5, or a 17.73% YTM and a 8.12% current yield. Both the notes trade on a 25% delta which is at best an approximate. Given the improved outlook for Nextel, we are recommending both of the above notes [for outright investors]. The 6s offer higher current yield while the 4.75% are shorter in maturity but still offer a competitive current yield."

Some key credit metrics for Nextel, he said, are cash at $2.7 billion and credit facilities of $1.5 billion available. Cash interest expense is $900 million for 2002 and $1.37 billion for 2003. During second quarter, he noted that Nextel retired $1.1 billion of debt and preferred on swap and cash. And, after the quarter's end, Nextel bought back $400 million in debt for $205 million in cash.

Cash usage decelerated in the last quarter, the analyst said, noting that prior to debt buybacks, cash usage was $86 million in the quarter, compared with an average of $481 million in the previous three quarters. Unleveraged free cash flow was positive for the first time on a quarterly basis at $155 million, he noted.

Going forward, he said, some key credit targets Nextel outlined aim to improve its credit rating to BB or better, improve the current debt/EBITDA ratio of 4 times to 4.5 times and perhaps swap additional debt in the future if it is accretive to all stake holders.

"Given the above initiatives, reduced capex projection and no CDMA (code division multiple access, a digital wireless technology) overlay till 2004, we do not see Nextel violating any covenant ratios in 2002," Aisola said.

"While we recognize the funding overhang, we are of the belief that any conversion can be delayed until after Nextel turns free cash flow positive in 2004. The urgency is further muted by the current liquidity situation, increased EBITDA guidance and wireless operator aversion to committing to capex-intensive upgrades."

Nextel 6% due 2011

Price: 57.5

Stock Price: $5.75

Conversion Premium: 138.37%

Conversion Price: $23.837

Current Yield: 10.43%

Market Delta: 25%

Yield To Maturity: 14.76%:

100-Day Vol.: 128%

First Call: 1.87 years

Call Price: 104

Spread: 1,000 bps over Treasuries

Credit Ratings: B/B3

Nextel 4.75% due 2007

Price: 58.5

Stock Price: $5.75

Conversion Premium: 140.66%

Conversion Price: $23.654

Current Yield: 8.12%

Market Delta: 25%

Yield To Maturity: 17.75%

100-Day Vol.: 128%

First Call: Current

Call Price: 102.714%

Spread: 1,000 bps over Treasuries

Credit Ratings: B/B3

Nextel 5.25% due 2010

Price: 54

Stock Price: $5.75

Conversion Premium: 598.72%

Conversion Price: $74.4

Current Yield: 9.72%

Market Delta: 25%

Yield To Maturity: 16.05%

100-Day Vol.: 128%

Call Price 103.5%

Spread: 1,000 bps over Treasuries

First Call: 0.49 years

Credit Ratings: B/B3

Nextel 9.375% senior notes due 2009

Price: 64

Yield To Maturity: 18.57%

Spread: 1,440 bps over Treasuries

Market Hedge: 0%

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