|Shares Out. (in M):||100||P/E||0||0|
|Market Cap (in $M):||200||P/FCF||0||0|
|Net Debt (in $M):||657||EBIT||0||0|
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Brazil. Cash burning. Covenant issues. Small cap. I’ll give you a few moments to gather yourself at the prospect of such an exciting potpourri of opportunity.
Okay, now we can get started. NIHD is a totally hated, completely orphaned, post-reorg Brazilian wireless telecommunication company with issues. Lots of issues. While the company has been written up several times on VIC (years ago), the pitch is different this time. NIHD is barely a business at this point – it burns cash on an unlevered basis, and is undeniably sub-scale. The company needs to be sold. The company should be thought of as a liquidity-runway -> M&A play – nothing more. In my opinion, the only reason to get involved in such a situation is when 1) there’s a reasonable runway on the option (2+ years of liquidity), 2) the downside is quantifiable/reasonable (arguable here, but probably not much worse than 50% downside), and 3) the upside could be big (easily 2-4x from here).
KEY STATS AND VALUE SENSITIVITY
I’ll spend a decent amount of time providing background and outlining the risks of the investment, but below is a chart that outlines the potential reward, which is useful in providing context to what follows.
For reference, NIHD generates ~$1 billion of revenue in USD terms and <$100 mm of EBITDA. While those are the USD numbers, all revenues, and almost all costs of the company are generated in BRL.
NIHD currently trades at a ~$850 mm EV (less than 1x revenue vs. comps at 1.5x+) with the shares at $2.00, and the various approaches I use suggest a value in the $1.2-1.7 billion range – inclusive of estimated cash burn, and not giving credit to the company for debt paydown attendant in my cash burn estimates. These EV ranges would yield a per share value of ~$5.50 to $7.50.
PRE-BANKRUPTCY AND BANKRUPTCY BACKGROUND
Some of the below is outlined in prior VIC write-ups, but I want to hit on the main historical points, as well as get the reader up to speed on relevant events over the past several years.
In the late 90s, NII Holdings (then Nextel International) was part of Nextel (yes, the Nextel of the ill-fated Sprint/Nextel merger). Nextel International filed for bankruptcy in 2002, and has operated as a publicly traded equity – NIHD. NIHD historically operated in 5 far-flung markets – Mexico, Brazil, Peru, Chile, and Argentina. All geographies operated Nextel’s propriety push-to-talk network (as distinct from TDMA, CDMA, and later 3G/4G).
From 2002-2013, NIHD had its ups and downs, but always had a strong core customer base in Mexico and Brazil. For example, when roaming was still a meaningful cost for wireless companies and consumers at large, NIHD (and its parent, Nextel) were famed for the ability to do long-distance, push-to-talk communication at no cost to the consumer. The push-to-talk network, or iDEN network, operated in the ~800 Mhz band of the spectrum. Notably, the iDEN network does NOT support data services (i.e., modern internet speeds).
The first crack in the NIHD story was that it was unable/unwilling (at least at the prices offered by gov’t entities) to purchase 3G spectrum in key markets while other, more capitalized players, did so. NIHD’s financial results during this period masked this strategic weakness as the legacy push-to-talk network generated robust revenue and profitability. While NIHD ultimately did purchase 3G spectrum, much of it wasn’t purchased until the 2013 timeframe, well after competitors.
The second crack to NIHD quickly turned into a chasm. In the summer of 2013, Sprint (remember the merger with Nextel’s U.S. operations) fully shut down its Nextel push-to-talk network to cut costs. While this had little impact on the combined Sprint/Nextel, it had a significant impact to NIHD and its customers. Despite the old push-to-talk technology, many NIHD customers in Mexico used the iDEN network to communicate with Sprint/Nextel relatives in Texas and other nearby states. While the coming “hard shutdown” was well-communicated to NIHD management (and the Street knew as well), through improper execution, bad luck, or otherwise, NIHD Mexico saw massive spikes in churn and customer care costs. NIHD Mexico saw revenue and EBITDA – historically in the ~$2,000 mm and ~700 mm range, respectively – plunge to ~$1,400 and negative EBITDA.
While the company still had significant cash resources at the time, the company began discussions with creditors in late 2013 and ultimately filed for bankruptcy in the middle of 2014. The bankruptcy was particularly painful and slow, with large investment funds taking chunky positions and arguing aggressively. The intercreditor fights aren’t germane to the investment thesis save one key point: the post-reorg equityholder base of NIHD is dominated by these former creditors.
The key event in the case that propelled NIHD out of bankruptcy was a large asset sale of NIHD Mexico to AT&T. Prior to this asset sale, most investors placed a relatively low value on Mexico given the issues described above (revenue declines, spikes in churn, and negative EBITDA). However, AT&T purchased NIHD Mexico for ~$1.9 billion, representing ~1.35x revenue and ~$660/sub. This unexpected cash infusion brought creditors to the table and NIHD emerged from bankruptcy in June of 2015.
NIHD emerged from bankruptcy in mid-2015 with a pretty clean looking balance sheet – only $850 mm of OpCo debt and ~$800 mm+ of cash (pro forma for NIHD Mexico sale escrow proceeds)– but its problems were far from behind it.
For the balance of this discussion, I’m only going to be talking about NIHD Brazil. Peru, Chile, and Mexico were all sold just prior to and during bankruptcy. Argentina was sold post-bankruptcy for nominal proceeds. Thus, the only material assets NIHD possesses at this point are Brazilian operations, spectrum, customers, and cash.
Q2 2015 Report, Going-Concern Language, Operational Weakness, Cash Burn – Oh My!
In its Q2 2015 10-Q – the first quarter post-bankruptcy – the company included “going-concern” accounting language. During bankruptcy, the ~$850 mm of OpCo debt (China Development Bank and local Brazilian Banks) provided waivers and extensions on covenants, but no amendments – including no post-bankruptcy amendments. Because the covenant schedule was created well before the company filed for bankruptcy, NIHD found itself in a position where it almost certainly could not meet financial covenants for the period 6/30/2016 – then one year away. This is, needless to say, highly unusual. One key reason to file for bankruptcy is to clean up liabilities and create a clear runway going forward.
For a lesson in “how not to do a press release,” take a read of the Q2 2015 press release that Nextel filed.
The CEO quote is just abysmally dire, and the company also announced it would provide no financial outlook nor hold a conference call. Nice.
Politicians and Oil (why do they always go together)?
While oil (oil and commodities generally being a huge portion of Brazil’s economy) began its fateful fall in late 2014, it initially had a limited impact on investors’ view of NIHD and its risk. However, leading up to and including the timing of its Q2 2015 earnings report, the Brazilian Real was falling fast. The Real fell from USD/BRL 2.20 in September 2014 to north of 4.00 one year later. Again, in the same timeframe, the Dilma impeachment and Petrobas scandal further eroded investor confidence in Brazil generally (to say the least).
Stock Decline – what now?
Who wants to own a small, crappy wireless telecom asset in the face of this? Well, the hedge funds who owned NIHD debt, and now post-reorg equity, definitely did NOT. NIHD stock was reborn at $16.00 when it emerged, and by September 2015, it was at <$9.00.
However, I would argue that since this truly awful confluence of events – some in management control, and some outside of it – NOTHING about the situation at NIHD has gotten worse. Indeed, in many cases things have materially improved. Yet the stock now trades at $2.00.
Political situation: Undeniably better and more stable. Look at what has happened with the Brazilian stock market generally
BRL: 3.11 (vs. 4.00+)
Cash Burn: Q2 quarterly EBITDA was reported at ~($80) mm. Each quarter it has improved sequentially, with Q3 16 reporting EBITDA of ~$20 mm. As I’ll show in my model, the company appears to have 2 years of liquidity remaining from here
Covenant Situation: Q2 2016 has now come and gone and the company is still truckin’; while the company didn’t obtain any go-forward amendments, the covenant was waived and the company continues to operate
Management: While the U.S.-based management team definitely has had its issues, the board hired a seasoned Brazilian wireless executive, Francisco Valim. Valim has done the yeoman’s work of slashing costs since he was brought in, and actually seems to have done a great job. Formerly the CEO of Oi , he has relationships with all the right people in the government and at other companies.
The best rational argument I can make for the continued decline in price from $9.00 to ~$2.00 (setting aside forced selling, name fatigue, etc.) is that the company – which has undeniably been for sale since it emerged – still hasn’t sold itself yet. Said another way, when a house on the block sits long enough without selling, investors (and potential buyers?) start to wonder “what’s wrong with it?”.
With all that as a backdrop, let’s start getting into the assets and the numbers. Besides ~$500 mm of pro forma cash, what the heck does NIHD (really NIHD Brazil) have?
It’s worth noting that “NIHD Brazil” is somewhat of a misnomer given how big and broad of a country Brazil is relative to where NIHD offers service. NIHD really only operates in the major cities of Sao Paulo (“SP”) and Rio De Janeiro (“RJ”) despite owning spectrum covering most all the country. While NIHD does have a roaming agreement with Telefonico (Vivo), SP and RJ are NIHD’s bread and butter. NIHD offers post-paid service while competitors typically offer a mix of pre- and post-paid service. NIHD’s customer is a “higher-end” customer compared to its comps. So why can’t NIHD generate money? Scale and competition. While I’ll discuss the competitive environment below, being a wireless telecom owner-operator is very capital intensive. The whole concept of NIHD as a standalone business is very challenging even under a benign competitive environment. Sticking with the subs for a moment, note that NIHD’s legacy iDEN customers are churning off rapidly – some become NIHD 3G customers; some don’t. While the importance of the pace of iDEN decline and NIHD’s ability/inability to re-market to these “churners” is arguable, what’s undeniable is NIHD’s 3G subscriber base would be quite valuable to any acquirer – albeit small relative to their overall customer base.
Subscribers aside, NIHD has a very valuable spectrum portfolio. While others on this board know far more about spectrum than I, wireless spectrum in the 800 Mhz and 1800/2100 Mhz bands is very much “down the fairway.” This isn’t GSAT. Wireless telecom incumbents could and would make use of NIHD’s spectrum now – or in the not too distant future. While the 800 Mhz spectrum is presently being used to service NIHD’s iDEN network, this can easily be repurposed for use in 4G/5G technologies (and that subscriber base is in terminal decline anyway). To that point, the Brazilian government recently auctioned off 700 Mhz (similar technological characteristics to 800 Mhz) television spectrum which is being repurposed for 4G/5G as we speak. Some could argue, “Aha! The incumbents just purchased spectrum similar to what NIHD has – they don’t need NIHD!” My response is pretty simple: tell me one wireless company in the history of the business that isn’t seeking more spectrum – particularly during a build-out from 3G to 4G.
I’ve been told that Brazil is one of only a handful of countries in a world with 4 major wireless competitors (and it’s 5 in RJ and SP, where NIHD operates). This situation persists arguably because of Brazil’s relatively socialistic and burdensome regulatory and tax environment. However, it’s hard to see how this situation will get much worse, and with the ongoing changes in the political environment in Brazil, one could argue there are reasons it could improve.
Compare and contrast the chart below to the U.S. – VZ and AT&T hold approximately 66% market share combined vs. Vivo and Claro at ~54%.
Furthermore, while I’m not intimately familiar with the ongoing restructuring at Oi, there appears to be a clear medium/long-term desire for more rationalization and M&A of the Brazilian telecom market. What exists currently just doesn’t work.
I should note here that for one of the incumbents to purchase NIHD, there would likely need to be either 1) spectrum/asset swaps (similar to what happens in the U.S. when M&A occurs) or 2) ease of regulations governing caps of spectrum (a whole other topic in Brazil that is reasonably complicated – if folks have an interest, let’s cover it in the comments). I don’t mean to hand-wave away this hurdle; I just simply feel that given NIHD’s size (small), and Brazil’s ultimate desire to rationalize wireless telecom, this will likely be a low hurdle to leap.
I believe the charts below are pretty self-explanatory, but these provide the basis for my valuation range described above.
AT&T Mexico M&A Comparison – This is basically comping the Mexico M&A purchase to Brazil’s current situation.
Brazil Spectrum Analysis – Imperfect, but gives you a sense of what 1) NIHD paid for 3G spectrum in 2013 (and I promise you it hasn’t gotten LESS valuable) and 2) implied pricing for the 800 Mhz spectrum given the recent 700 Mhz auction. Notably, this includes NO value for NIHD’s customers or cash flow. It’s just for its spectrum.
Local Buyer M&A Analysis – This is a high-level thought experiment using my 2018 local currency estimates for NIHD (e.g., 452 mm Real equates to ~$140 mm EBITDA), estimating synergies and applying a discounted multiple to show what a potential incumbent could pay for NIHD with cushion and still generate value.
I’m happy to answer any questions in the comments.
2018 EBITDA SENSITIVITY
This gives one a sense of the key drivers in coming up with an EBITDA estimate for the company.
Below is my liquidity model for NIHD. This illustrates the company can easily get through 2017, and appears to have sufficient cash to get through 2018 as well.
Brazil: It’s Brazil.
Currency: It’s Brazil.
It hasn’t been sold yet – something must be wrong: Can’t really argue with this one except to say things move very s l o w l y in Brazil
The stock has been trading poorly so long that no M&A buyer will pay a significant premium: I actually worry a fair bit about this one. Paying $5.00 for the stock is such a silly sounding premium relative to $2.00. To get comfort, I look at other situations like LKND, where the stock was hammered and then MSFT paid something in-line with the price pre-collapse
It doesn’t make money on an unlevered or levered basis: Don’t put all of your mom’s life savings into this. NIHD needs to sell for the stock to work
Regulatory hurdles to M&A: For example, issues with spectrum caps
Covenant issues: These haven’t, and probably never will, be solved (until and if the company sells itself). The reason I don’t worry much about these covenants are 1) the lenders, if they took the reins, would tell the company to “sell,”, which they are realistically already trying to do… and 2) the lenders have had a lot of opportunities in environments far worse than the present situation to cause problems, and they haven’t
Liquidity: ~$170 mm of liquidity is contingent on release from escrow by AT&T (from the sale of NIHD Mexico) in the middle of 2017. While the company would still make it through 2017 if this sum was delayed, 2018 would be much more challenging/impossible and probably cause another bankruptcy/rights offering/some form of dilution
The big boys don’t “need” NIHD: Probably true. But if you had the choice to buy something cheap enough (and NIHD is demonstrably cheap), why would you pass up the opportunity?
Awful holder base: Relatively closely held by legacy debtholders. Don’t let CapRe showing up on the list fool you into thinking there is long-only support here; CapRe owned NIHD bonds prior to bankruptcy, and still hold the stock they received on account of that. While it sounds like an excuse, I really do believe that the bad holder base and stupid/sloppy selling accounts for most of the move from ~$9.00 to ~$2.00.
Earnings: While the stock does move around earnings, it never appears to be logical or in-step with what the company reports. There does tend to be a decent uplift in trading activity around earnings events, if nothing else
M&A: The big enchilada; impossible to time
Regulatory change/shift: Hard to predict, but it really does seem like the gov’t is serious about trying to improve the situation for wireless carriers and is amenable to M&A
While NIHD certainly isn’t without its risks (what potential 2-4+ bagger is?), it seems to me to be reasonable reward per unit of risk. That said, I welcome any questions or criticism. Thanks
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