Wachovia: time for hedge investors to build position in Nextel

By Ronda Fears

Nashville, Tenn., Nov. 5 - For a number of reasons, Wachovia Securities, inc. analysts said in a report Tuesday that hedged investors should begin building a position in the Nextel Communications Inc.'s convertibles.

"Nextel's bonds are becoming increasingly attractive for hedge investors in addition to outright investors," said analysts Jeanine Oburchay and Brian Park.

On Oct. 22, the analysts recommended that outright accounts take a position in Nextel.

Since then, Nextel's 4.75s have added 10.5 points, the 5.25s are up 7 points and the 6s up 13 points.

The conversion premiums also have shrunk considerably on all three issues.

"We still believe the return on Nextel's 4.75% and 6% convertible bonds are attractive enough for outright accounts, but we also believe hedge accounts should also begin building positions in the name," the analysts said.

However, the analysts also said that conservative outright investors should swap out of the 4.75s into the 5.25, which have the highest current yield at 7.2% and a yield to maturity of 10.7%.

"We expect that if the stock goes to $19, the 5.25% bonds will go to 77 for a total return of 12.7%. These bonds also have the best downside protection, with negative 1% downside participation," the analysts said.

A big factor in Nextel's improvement is that it has bought back more than $2.5 billion in debt to date.

The company bought back $1.5 billion in debt and preferreds in third quarter, on top of the $1.1 billion bought back in second quarter, the analysts noted. The company paid $394 million in cash and 83 million shares of stock to buy back the debt and preferreds.

Nextel now has nearly $3.9 billion in liquidity, with $2.4 billion in cash and equivalents plus access to $1.4 billion from its credit facility.

"We believe the company will continue to buy back debt, most likely the converts, and will be more likely to use stock to do so as the stock moves up," the analysts said.

"As the company has aggressively delevered, we believe a lower discount rate is warranted when valuing the equity."

As a result of a lowered discount rate, continued debt buybacks and a higher confidence level in the name, the analysts raised their price targets on the stock to $19 from $12. They also are looking for the 4.75s to gain to 96 from 85 and the 6s to go to 101 from 85.

The analysts used a credit spread for Nextel of 900 basis points, tightened from 1,000 basis points a few weeks ago. Because Nextel has always been perceived as a risky credit story, the analysts noted, any movement in the stock has historically been linked to a movement in the credit spread.

They used a volatility assumption of 68%, as January 2005 calls at $20 currently have a bidside implied volatility of 68%.

"We believe there are several risk factors, including but not limited to headline risk, market perception and the possibility of poor fundamental performance that could prevent Nextel from reaching that [stock] valuation," the analysts said.

"Nonetheless, our DCF model shows that it could be a $19 stock."

Nextel 4.75% convertible due 2007

Price: 89.5

Stock price: $13.00

Conversion premium: 62.6%

Current yield: 5.3%

Yield to maturity: 7.5%

Call: Currently at 102.714

Nextel 5.25% convertible due 2010

Price: 73

Stock price: $13.00

Conversion premium: 440.8%

Current yield: 7.2%

Yield to maturity: 10.7%

Call: January 2003 at 103.5

Nextel 6.0% convertible due 2011

Price: 89

Stock price: $13.00

Conversion premium: 63.2%

Current yield: 6.7%

Yield to maturity: 7.8%

Call: June 2004 at 104

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