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The Air's Getting Thin After Nextel's Climb

The shares have surged, but big risks -- including massive debt and competition -- remain.
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shares jumped to a 52-week high Thursday after months of steady gains. Is it time to buy? Perhaps. But a bet on Nextel isn't without risk.

The No. 5 wireless carrier's shares have more than quadrupled since June, thanks to its efforts to pare down debt -- but such a dramatic expansion may not be justified, given the company's goliath $12 billion debt load, growing competition in the industry and a slump in new wireless customers.

"There's a laundry list of things that could keep upward pressure of the stock," said Jeff Bray, a telecommunications analyst at David L. Babson, a money-management firm. "It's going to be tough over the long term. It's realistic to expect that they can cover the interest. But it's going to be tough to amortize

the debt for sure."

While medium-term interest payments aren't a concern -- Nextel bonds don't mature until 2007 and it generates enough cash to cover any payments next year -- the company's net debt is nearly 35% more than its estimated revenue for next year, according to sales forecasts from Thomson Financial/First Call.

Also, competition is stiff. The nation's No. 1 carrier,

Verizon Wireless

, and No. 3 carrier,

Sprint PCS


, are both looking to offer services similar to Nextel's next year that may "steal from Nextel's growth," said Thomas Weisel Partners telecom analyst Ned Zachar.

Moreover, investors worry that the company will need to upgrade its networks in order to someday offer high-speed wireless-data services. For now, Nextel plans to make lower-cost improvements to its current hardware that essentially will double the network's voice capacity by next year. But it's unclear how the company will fund any major upgrades.

Nextel spokeswoman Audrey Schaefer said, "It would be premature to discuss how we would proceed, considering we don't have a timeline for moving to the next generation or selected a technology." She added, "The enhancements we are making to the existing platform give us 3G-like capabilities today. When we see that there's a clear return on an investment, we will pursue technologies that make sense for our customer."

As for the company's debt, she said, "Our coverage ratios are better than most in the industry and on par with the best. We just continue to pay the interest. We are in good position."

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Another issue that may keep investors up at night is the fact that one of the company's largest shareholders, Craig McCaw, has begun hedging his shares in Nextel. McCaw, known in the industry as the godfather of modern cellular communications, invested $1 billion in the cash-strapped carrier in 1995 and has continued to invest close to $1 billion in Nextel shares over the years. He now owns an 8.1% stake.

Recently, the telecom executive has entered into a series of complex "forward sale" agreements on around 40% of his shares to shield himself from declines, according to

Securities & Exchange Commission

filings. These agreements protect him against a drop in the stock price by locking in a certain price, while also limiting the benefit he would see from future increases in the price. McCaw's firm, Eagle River Inc., didn't return calls for comment.

Furthermore, the company's ability to buy back its debt at dramatic discounts is disappearing, some analysts say. "The return rate has eroded somewhat as bonds have rallied," said J.P. Morgan wireless services analyst Thomas Lee in a research note. "Going forward, we expect the company to slow down its debt-buyback program as economics are less compelling."

So why haven't investors fled Nextel? Quite literally, the bottom line. "The company will have earnings next year,

and that will make a difference to investors," said Barbara Marcin, fund manager of the $26 million Gabelli Blue Chip Value fund. Nextel expects to swing to a profit of 64 cents on revenue of about $9.9 billion in 2003, according to First Call estimates. (Nextel makes up about 3% of the Gabelli fund's assets.)

A look at the company's valuation can also make the stock compelling. Sanford C. Bernstein wireless analyst Alex Trofimoff said the stock trades are at a slight discount when taking into consideration its enterprise value (market cap plus debt, minus cash) as a multiple of 2002 earnings before interest, taxes, amortization and depreciation.

Thomas Weisel's Zachar added, "From a valuation perspective,

Nextel investors are paying

prices similar to Sprint PCS, without the difficulties. And you're paying a premium to AT&T Wireless, but with real momentum and earnings."

Looking ahead to next year, analysts expect the company to record a compounded annual growth rate of 31% from 2003 through 2007, slightly slower than

AT&T Wireless's


estimated 35% rate, according to Bear Stearns estimates. Bear Stearns cut its rating to peer perform from outperform in early November, advising clients to take some profits due to the stock's run-up, but maintained a bullish stance on Nextel's fundamentals. Bear Stearns has done investment banking for Nextel.

Nextel shares first began to take off after two quarters of unexpectedly strong results. In July, the company posted second-quarter profit of $325 million, or 37 cents a share. In October, the company said third-quarter net more than doubled to $526 million, or 58 cents a share. At a time when competitors were losing customers, Nextel added nearly a million new ones. Average revenue per subscriber, a closely watched metric, was also way above the competition.

But what really ignited investors' enthusiasm was Nextel's efforts to cut its debt. Since the beginning of this year, the company has issued 144 million new Class A shares and has paid $689 million in cash to buy back $2.6 billion in debt. The company said the move will help it avoid payments of approximately $4.4 billion in principal and interest over the life of the securities, or about $235 million a year.

Investors liked the sound of that. On Thursday, the stock closed up 29 cents at $14.01, a 52-week high. Noted Gabelli's Marcin, "Nextel has more risk,

but where there's more risk, there's more opportunity."