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How to play the coming 3G spectrum auctions for fun and profits!
You know it's coming and you gotta make a buck
by Briton Ryle
Last month's Agora Wealth Symposium was held in Las Vegas, the most strangely wonderful and horrifying place in America. I recently wrote about the national obsession with getting rich quick, but I had no idea.
Vegas is overwhelming. And the sinister intention of the place is obscured beneath a whirlwind of opulent hotels, amusement park rides, X-rated hypnotist acts, all-you-can-eat lobster and prime rib buffets, dancing girls, and free booze. Of course, there's no such "buy you dinner first" courtesy on Wall Street.
Like the stock market, Vegas is there to take your money. But the true genius of the place is the way it makes people feel good about getting fleeced. Drop a grand on craps and it's just "part of the experience."
Funny that the old men who sit at the poker tables taking piles of chips from the rubes rarely crack a smile. This is business to them. And I got the feeling they win more than they lose.
It's no different in the financial community. Witty, lighthearted TV ads invite you to a fun online trading party. But once inside, your hosts turn out to be humorless analysts and market strategists who offer biased advice as if they had your best interests at heart. Nothing could be further from the truth.
Too little, too late
How do you explain downgrading Intel after it's dropped 30%? Or Motorola getting kicked in the pants? Nokia, Ericsson, LSI Logic...the list goes on and on. Oil stocks are being recommended when oil is likely at the top of its cycle.
And this gets to the heart of why the recent Agora Wealth Symposium was such a great event for investors and speculators alike. Experts in natural resources, technology, foreign currency, bond and income investing, all offering insights into their field of expertise.
I saw firsthand how important it is for Taipan members to have us working for you. Seriously, now: We're not in the back pocket of some company that just went public. We're not here to protect the interests of our big clients at the expense of other investors. We're here to give you a unique view of the financial world. And how well we do the job determines whether we can put food on our tables.
Seeing the future
Verizon was recently downgraded by AG Edwards. Of course, the stock's at a 3 year low. Hambrecht downgraded Sprint's wireless group just days after a 25% selloff. And just in time to see the stock jump from US$28 to US$37 in a little over a week. Investment houses lined up to downgrade Nokia when it forecast lower sales growth and profit margins for its third quarter.
Solomon Smith Barney, Morgan Stanley, DLJ, Bear Stearns, Lehman Brothers and Bank of America all downgraded the stock after it dropped almost 20%. Two of the six had rated Nokia a strong buy before the earnings warning and one even considered it a top pick.
France Telecom, Deutsche Telecom, and British Telecom had their credit ratings cut and watched their stock prices drop between 20 and 25% after acquiring 3G licenses in Europe. And the same thing will happen again in the U.S. Any time you know an event is coming, you should at least try and find a profit opportunity in it. And, by George, I think I've got it.
Profit from the inevitable
At the Agora Wealth Symposium, I outlined a strategy for investing in wireless carriers that I'd like to share with you. I'm going to recommend two wireless carriers that are likely to rally by the end of the year — and then get downgraded when U.S. 3G spectrum auctions come around. This gives Taipan members two opportunities to profit.
My strategy should yield 50% profit on each stock in the next six months, and give Taipan members positions in two strong wireless carriers. I also believe both companies could easily be acquired during this timeframe.
The winners are...
My two favorite wireless carriers are Sprint PCS (PCS:NYSE) and Leap Wireless (LWIN:NASDAQ). I know, it sounds like an Olympic event: the 100-meter sprint and leap. Although the fundamentals of each company are different, the timeframe and catalyst for both plays are roughly the same.
Before I outline how to profit from current misperceptions of wireless carriers, it's important to understand what's going on behind the downgrades. In general, there are two possible causes for a downgrade — revenues and costs. In this case, both are present.
The driver's seat
The controversial driving force behind the future of the wireless sector is the wireless Internet. Bringing data to the cell phone requires three things: more spectrum, new phones and faster networks. The reason behind the warnings at handset manufacturers Motorola and Nokia is that right now mobile phones are between generations. Voice-only phone sales are slowing, and Internet phones have yet to pick up the slack.
Carriers are currently adding capacity to networks and acquiring new spectrum. The result: companies are spending more and earning less. Both issues are real. They're also temporary. And if you understand what's going on, you can fearlessly take positions in strong companies while the investment community at large says the sky is falling.
The success of NTT DoCoMo's wireless Internet service in Japan is well documented. And I don't see a reason to think such services will be any less popular in the U.S. and Europe, over time. That's the key to this whole puzzle — time. The promise of the wireless Internet will take time and money. But once networks are in place, revenues will more than cover the investment.
The companies
About 2 years ago, Sprint split its operations in two. One stock, PCS, tracks the wireless side of the business. The other stock, FON, covers the long distance and data side. I'd avoid FON stock like the plague.
Sprint owns and operates one of two national CDMA wireless networks in the U.S. (Verizon has the other.) It currently has around 7.5 million subscribers. And, along with Verizon, it's leading the push in the U.S. to offer Internet data and entertainment to mobile subscribers.
France Telecom and British Telecom own 20% of Sprint Wireless. In addition, Sprint has partnered with Microsoft and Yahoo! to deliver content. There's no doubt that France Telecom, British Telecom, Yahoo! and Microsoft want a piece of the U.S. wireless market. And Sprint is their ticket. Expect to see some combination of these five companies form a consortium to bid on 3G spectrum.
Market misperceptions
Sprint was unduly hammered when it announced that subscriber growth for 3Q would be 12% slower than predicted. If slowing subscriber numbers were the trend, then the 30% selloff would be justified. But there are some signs that subscriber growth figures will be stronger after the next couple of quarters.
One factor that contributed to the growth shortfall is actually very positive. Sprint will cancel the accounts of some users who don't pay their bills. Absolute subscriber growth may suffer, but the quality of revenues and profit margins should increase.
I believe that price of service is also a factor. Sprint already has competitive pricing plans. And they don't have the network congestion problems that AT&T Wireless (AWE:NYSE) does. Besides, AT&T's network technology, TDMA, is the least ready for the added traffic that 3G will bring.
As wireless service plans come down in price, people will begin migrating from circuit-switched phones to wireless as their primary phone link. In fact, if you're in the right area, you can already get unlimited local service from one trendsetting wireless carrier. More on that a little later.
Buy Sprint under US$35
Sprint currently trades in the mid 30s, and is one of the best bargains in the space. Remember, MCI Worldcom offered US$129 billion for Sprint. That offer represents a 50% premium over the current price. And I doubt Sprint would accept much less for future acquisition offers.
The acquisition scenario is gravy and shouldn't be counted on. What I am counting on is this: Wall Street went overboard when it sent Sprint PCS into the upper 20s. Mistakes like that don't last. I expect to see Sprint return to the low 40s during any sustained rally on the NASDAQ.
We'll need to sell in February, before the U.S. 3G spectrum auctions get underway. The inevitable downgrades will give us another sweet entry point.
Part 2
This strategy should work for any of the major U.S. wireless carriers. But I think Sprint PCS and Leap Wireless are the best carriers to own. I've talked a little about Sprint. Here's the lowdown on Leap.
Leap Wireless was spun off from Qualcomm 2 years ago. Former Qualcomm co-founder and president Harvey White is Leap's CEO. Mr. White is wireless a visionary who pioneered the flat-rate wireless service plan through Leap's subsidiary, Cricket.
I first discovered Leap during a small market spectrum auction in the spring of 1999. Since then, the company has acquired spectrum in over 50 cities in 27 states, covering 45 million potential subscribers. 35 cities will be operational by the end of next year. In addition, it has a 28% stake in Mexican carrier Pegaso. Interesting to note that Sprint also owns 30% of Pegaso. Leap recently sold its stake in a Chilean wireless venture for US$300 million.
The promise of flat-rate wireless plans in emerging markets is especially exciting. In countries like Mexico, people who live outside a major metropolitan area have virtually no chance of ever getting copper to the home for landline phone service. Wireless is their only hope. The one risk is that such populations are usually pretty poor. To ensure against unpaid bills, Leap added the words "prepaid" to its flat-rate plan.
Stealth play
Leap is still building out networks in its coverage areas. That means it's losing money. But losing money isn't a huge concern for Leap because of its relationship with Qualcomm. Of course, Leap has entered into the usual equipment loans with companies like Lucent and Ericsson. But it's this relationship with Qualcomm that's really interesting.
Qualcomm is loaded with cash. And after selling off virtually all of its divisions, they may be looking for something to do with the long green. I believe Leap represents a stealth play on the wireless web.
The big dance
There's still a lot of companies looking for a dance partner for the big U.S. 3G hoedown. But carriers are getting scarce. Short of a buyout, Sprint's dance card is full. And Verizon, partly owned by the U.K.'s Vodafone, is probably also spoken for. AT&T Wireless and Nextel will both have to shell out huge amounts of cash to upgrade technologically inferior networks. I wouldn't look favorably on any partnerships involving these two.
An FCC official told me there's nothing to prevent the AOL/NTT DoCoMo alliance from bidding on U.S. spectrum. But first I'd expect them to bring an established U.S. carrier into the fold. The same official said that Cisco and PSINet showed some initial interest in bidding in a recent 700 MHz auction.
Leap is an outside shot as a 3G auction participant. But even if it doesn't enter the bidding, it's still an excellent investment on its own merits. I consider Leap a good buy under US$50.
Let me repeat
The object of this strategy is to take advantage of recent and future weakness in wireless carriers. Sprint and Leap are both well off recent highs, and I expect at least 20% appreciation in each stock by the end of the year. We should be able to sell with a nice profit in January, well before the U.S. 3G auctions get underway.
As it becomes clear that the U.S. auctions are going to be obscenely expensive, we should see a swarm of analysts knocking these stocks back down to very attractive levels. This play is all about timing. If we miss the entry points, we'll wait and see what happens. It's never a good idea to chase a stock. As always, if you'd like more information, please contact the companies.
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