The Target on Nextel's Back

Rival wireless companies are aiming directly at it's popular Direct Connect feature. Chances are good, though, that they'll miss

By David Shook

If one cell-phone company stands out from the pack, it's Nextel (NXTL ), whose 10 million subscribers make it the fifth-largest mobile-phone operator in the U.S. A lesser-known wireless player among consumers, Reston (Va.) Nextel targets businesses rather than the lower-margin U.S. consumer sector, where six rival are duking it out for market share.

Nextel's difference? The push-to-talk (PTT) function on its cell phones, which in essence works like a walkie-talkie, gives it a huge technological advantage in marketing to many business users. The feature, called Direct Connect, allows construction workers, police officers, firefighters, sales reps, and the like to speak with one another instantly at the push of a button.

For several years, Nextel's rivals have coveted this technology, says Rashad Barajakly, analyst for Williams Capital Group. And in 2001, Verizon (VZ ), Sprint (FON ), and Alltel (AT ) announced their intention to introduce a competing PTT product sometime in 2003. The other players -- AT&T Wireless (AWE ), T-Mobile, and Cingular Wireless --- have expressed interest but have offered no detailed plans.


  The posturing among the larger rivals presents a formidable challenge for Nextel: Will its competitive advantage begin to erode next year? How safe is Nextel's stock, which has climbed from a record low of $3 per share in July to $12.68, as of Dec. 20.

The reality is that Nextel probably won't lose its lead in the business-communications market anytime soon. In fact, it may just open the gap, some analysts believe. Nextel also has the highest revenue per user and the lowest subscriber turnover -- or customer churn rate -- among all national mobile-phone players, according to Legg Mason and statistics from mobile-phone trade groups. Nextel averages $71 per customer per month in revenue, while the comparable figure for the industry overall comes in at just under $50. Moreover, Nextel's churn rate is 2%, vs. an industry average of 2.7%.

That should keep the stock from plummeting, says Craig Mallitz, an analyst at Legg Mason, which has no banking ties to Nextel. Legg Mason has a buy rating on Nextel and a price target of $17 per share. Even if rivals do roll out PTT offerings, Nextel has huge advantages, says another analyst for a Boston technology-consulting firm.


  Indeed, Nextel has begun to turn the corner on profitability after several years in the red. In the third quarter of 2002, Nextel posted net income of $383 million, or 55 cents a share, on revenue of $2.3 billion, vs. a loss of $150 million, or 27 cents a share, on $1.8 billion in revenue a year ago. For the full year, Nextel says it will add 1.9 million net additional subscribers, about the same number as in 2001. Analysts expect to see reported earnings of 12 cents a share for the fourth quarter, vs. a loss of $2.24 a share a year ago, which included restructuring charges.

Nextel's competitive advantage comes down to a matter of seconds. That is, its proprietary technology, developed by partner Motorola (MOT ), relies on cell phones that are in communication with the local-network towers virtually every second. Users can conduct a private two-way radio communication over cell phones or interact with multiple co-workers or clients across town. They don't have to dial numbers or make elaborate preparations for a conference call. As long as other users' Nextel phones are turned on, a caller can push a button and reach them in a second.

On all other mobile-phone networks, handsets send a signal to the towers every 6 to 10 seconds, indicating that the phone is nearby and available to receive a call. This signal gap in most cell-phone networks creates an obstacle for companies trying to develop their own PTT functionality. At any given time, a phone on a standard mobile network may not receive the PTT signal for several seconds. A 10-second delay "may seem like an eternity," analyst Craig Mallitz says. Why not just dial the number instead?


  The technology is supported by a unique telecommunications framework, says Nextel Chief Technical Officer Barry West, who often talks about the ways that Nextel phones are a big help during major events and emergencies. After the September 11 terrorist attacks, he noted, "when the other phone networks were bogged down, police and firefighters relied on Direct Connect."

And it isn't only technology that gives Nextel an advantage in attracting business customers. Over the past several years, it has established regional-industry networks in all major U.S. cities. So, if an electrician in Detroit enters a Nextel store, he's told that most electricians in the Motor City already use Direct Connect. These mini-monopolies could be tough for competitors to crack. If Sprint or Verizon offer PTT to, say, plumbers in Atlanta or Chicago truckers, these potential customers would be buying a PTT system that's incompatible with Nextel's -- the industry standard.

Furthermore, while some rivals are planning to roll out basic PTT functionality next year, Nextel says it intends to begin offering Direct Connect as a nationwide service by mid-2003. Right now, users can reach one another via Direct Connect within a certain geographic region, such as metro Boston or the New York City tristate area. Beyond that, Nextel says it's working with Qualcomm (QCOM ) and Motorola to expand PTT to the global level -- allowing a shipper in Beijing to speak instantly to a receiver on the docks in Los Angeles.


  Eventually, Nextel's huge advantage could dissipate, analysts acknowledge. All six rival carriers might have a PTT technology similar to Nextel's in several years. However, it will take huge capital expenditures, new handsets for every consumer who wants the service, and possibly an increase in spectrum capacity, Mallitz says.

Further, it's far from certain that competitors will be able to get it right in just a year or two, given that it took Nextel a decade to work out Direct Connect's kinks. Plus, "investors don't want to hear about huge new capital-spending plans in the telecom sector right now," says Barajakly of Williams Capital.

It's no wonder Nextel's West sounds confident. Told that rivals are talking about eating his outfit's lunch, he replies: "I think we're going to be eating our own lunch for quite some time." Holders of Nextel stock aren't likely to go hungry in the near term, either.

David Shook is a writer for BusinessWeek Online in New York

Edited by Beth Belton

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