Friedman analysts suggest building a position in Aether convertibles

By Ronda Fears

Nashville, Tenn., May 9 - Friedman Billings Ramsey high-yield bond analysts David Marsh and Min Cho reiterated a recommendation to begin accumulating a position in the Aether Systems Inc. convertible notes, which were quoted at 70 bid, 75 offered on Thursday. If the bond falls to 60 or lower, the analysts said they would be aggressive buyers.

"We continue to believe that the 9.2% current yield on a three-year note adequately compensates investors to wait for a positive catalyst to drive the price higher, especially given the continued improvement in EBITDA loss that the company exhibited in first quarter, and would begin accumulating a position in the convertible notes at this time," the analysts said in a report.

"We would be aggressive buyers on the notes if the price dips below $600 per note (10% current yield; 27% YTW), as we feel that downside risk at that level is substantially mitigated by the company's large cash position (approximately 1.6x total debt)."

The Aether converts were quoted higher on the stock rise of 86c to $4.28, and are more active on high yield desks than convertibles desks.

Aether was gaining, traders said, on renewed rumors about IBM making a move to acquire Aether. But, traders said the talk was unsupported and most of the market was skeptical about it.

"It's just a rumor. That has been something that has long been rumored about this company and nothing has happened," Marsh said.

"Once the rumors subside, the bonds will come back in."

While the sequential decline in revenues in first quarter was disappointing, continued reductions in cash operating costs, which led to a sequential improvement in EBITDA, are very encouraging, the analysts said.

Aether reported an EBITDA loss of $26.2 million in first quarter, down 22% from a $33.8 million EBITDA loss in fourth quarter, and marked the fourth consecutive quarterly improvement. The improvement was driven by a large reduction in cash operating expenses and a modest 41 basis point improvement in gross margins.

First quarter revenues came in at $23.7 million, down 6% sequentially from fourth quarter revenues of $25.2 million. Cash burn was $52 million, down significantly from $65 million in fourth quarter.

The company ended the quarter with $477.5 million in cash and equivalents.

"We would be inclined to raise our rating if the company can demonstrate an ability to generate organic revenue growth," the analysts said.

Most of the revenue growth forecast for second quarter comes from the @Track acquisition, and the analysts said that organic revenue growth is necessary to validate Aether's business model and drive the price of the convertible notes higher.

Aether projects second quarter revenues will rise sequentially to the high-$20 million range. The Friedman analysts are forecasting second quarter revenues of $27.1 million, primarily driven by an increase in subscriber revenues as a result of the @Track acquisition.

By first quarter 2003, Aether management continues to project the company will be EBITDA positive. The Friedman analysts believe the company will have some $392 million in cash and equivalents heading into first quarter 2003, when the company is expected to be EBITDA positive.

The risks in holding Aether bonds, the analysts said, include limited operating history, a dependence on third-party networks and devices, competition and stock price volatility.

"As the market for mobile wireless data is still in its early stages, there is uncertainty regarding the overall demand for these services," the analysts said.

"Access to skilled engineers and other technical personnel is key to future success. Attracting and retaining skilled employees will be critical to the company's ability to maintain its leadership position long-term. This is a relatively new industry, and this arena is likely to attract new and very large competitors."

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