March 8, 2007, 7:11 am

Clearwire - CLWR

2007-02-21
CLWR - Clearwire

CLWR - Clearwire plans on offering 23 million shares (assuming over-allotments) at a range of $23-$25. JP Morgan, Merrill Lynch and Morgan Stanley will be lead managing the deal, seven other firms co-managing. Post-offering CLWR will have 161 million shares outstanding for a market cap of $3.864 billion on a $24 pricing.

CLWR also has what I consider excessive option and warrant shares outstanding. Over the next 1-2 years there will most likely be a 35-37 million shares dilution coming from already exercisable options and warrants. That is at minimum a 21% dilution in sharecount to ipo shareholders directly due to options and warrants. CLWR will also need to access the capital markets at some point in the future. There is a very strong chance of at least one dilutive secondary over the next year or so.

IPO proceeds will be used for market and network expansion, spectrum acquisitions and general corporate purposes.

Entities controlled by Founder and Chairman Craig McCaw and CEO Benjamin Wolff will own 33% of CLWR post-ipo, Intel will own 29%. Motorola will also have a 10% ownership stake post-ipo. Craig McCaw and Benjamin Wolff will retain voting control of the public CLWR through a separate share class. Both Intel and Motorola made a substantial investment in CLWR in 2006. In return for the cash infusion, each received shares and agreements to partner with CLWR in building out a WiMAX network and producing equipment for said network.

Mr. McCaw is the reason this CLWR is getting done at this hefty market cap. Mr. McCaw, age 57, is a cellular phone pioneer who sold his company McCaw Cellular Communications, to AT&T Corp. in 1997 for $11.4 billion.

From the prospectus:

'We build and operate next generation wireless broadband networks that enable fast, simple, portable, reliable and affordable Internet communications. Our wireless broadband networks cover entire communities and deliver a high-speed Internet connection that not only creates a new communications path into the home or office, but also provides a broadband connection anytime and anywhere within our coverage area. We intend to evolve our network and the services we provide to facilitate a greater range of mobile communications services than we currently offer.'

CLWR is building their high speed wireless network based on WiMAX technology. CLWR's goal is to provide high speed wireline type services over broad area wireless networks. CLWR believes WiMAX technology enables them to combine the best features of cellular, cable modem, DSL, and WiFi networks into a single service offering that legacy networks cannot match.

CLWR feels their advantages over existing wireless networks include: 1) speeds competitive with wireline broadband offerings; 2) Portable - accessible anywhere within a CLWR enabled community. 3) Reliable - CLWR is the sole licensee on their networks, which enables them to minimize interference common on certain wireless networks that use unlicensed or shared radio frequencies.

CLWR was founded in October 2003 by Craig McCaw. Their first network was launched fairly recently, in August 2004. As of 12/31/06 CLWR's network in the United States is deployed in 34 markets across more than 350 municipalities and covers an estimated 8.6 million people. Considering the US population is approximately 300 million, CLWR's coverage area is still fairly limited, available to a little less than 3% of the current US population. In addition CLWR offers their wireless broadband services in Brussels, Belgium and Dublin, Ireland, where the network covers approximately 1.0 million people.

As of 12/31/06 wireless broadband Internet subscribers totaled 206,200. For the most part, CLWR's covered areas have consisted of 'test cases' in smaller metro areas. In late '06, CLWR launched their service in their first 'top 20' metro area, Seattle. Prices for the service range from $25-$40 monthly for Internet access. At the lower pricing, the speed is comparable to low speed DSL. At the higher end, speed is slightly lower than high speed cable. CLWR also offers Internet phone service for an additional charge. Note, currently CLWR's wireless modem requires to be plugged in to operate. So, while Internet access in a given area is 'anytime/anywhere', one does need to be near an electrical outlet. Also, all users in a given area share the throughput. More users could lead to slower speeds without either additional spectrum licenses or more towers.

In 2006, CLWR launched service in 9 new metro areas, 7 during the second half of the year.

WiMAX - I'll just quote from the prospectus here: 'Our advanced wireless broadband network currently relies on network infrastructure equipment that is based on proprietary non-line-of-sight, or NLOS, Orthogonal Frequency Division Multiplexing, or OFDM, technologies. We have committed to deploy networks based on the IEEE mobile Worldwide Interoperability of Microwave Access 802.16e-2005, or mobile WiMAX, standard once mobile WiMAX equipment is commercially available and meets our requirements.' Note the phrase, 'once WiMAX equipment is commercially available.' As of now, mobile WiMAX technologies have not yet become commercially available. CLWR will have a $3.8 billion market cap on a $24 pricing, and the equipment to communicate over the planned network buildout is not yet commercially available. Currently CLWR's networks and equipment do not operate on WiMAX; they are using something CLWR refers to as 'pre-WiMAX' or 'Expedience'.

Intel and CLWR are developing a mobile WiMAX service that will be available only over CLWR's network. Intel is a minority owner of CLWR and has devoted substantial R&D expense developing WiMAX equipment and networks. Intel is also manufacturing equipment for this expected service. Currently Motorola manufactures CLWR's 'Expedience' equipment.

CLWR believes they've the second largest 2.5G spectrum license position in the US. Sprint - Nextel has the largest 2.5G spectrum license position. After factoring in the recent purchase of all of AT&T's 2.5G spectrum licenses, CLWR's 2.5G licenses will cover areas in which approximately 250 million US residents reside. In addition CLWR has 3.5G spectrum licenses that cover approximately 200 million residents in Europe.

Industry - The US residential broadband market is anticipated to grow 14% annually over the next 4 years and exceed 68% penetration of US households by 2010. The North American WiMAX market is expected to increase from the current 30,000 installed bases to 21+ million by 2011. As broadband penetration grows, CLWR also hopes demand for anywhere high speed wireless Internet access via WiMAX will also increase substantially.

Strategic relationships - CLWR is still in the early stage of their buildout. Currently they offer services in areas in which only 3% or so of the US population resides. In addition, their focus is on the fledgling WiMAX technology for which mass produced equipment does not yet exist. Money and partnerships will be a key to whether or not CLWR sinks or swims. They do have three strong partners in their minority shareholders- Intel, Motorola, and Bell Canada. Currently, and in the future CLWR will need to rely on the three partners for access to equipment, deployment of mobile WiMAX and development of other value added services, such as VoIP telephony.

Competition - In this space, the competition is brutal. Cable, DSL, cell companies developing and promoting 3G and other high-speed wireless networks, municipalities installing Wi-fi city-wide, satellite etc...you name it pretty much. What this means is that high speed data communications will become a commoditized product offering over time. Fully expect more speed at lower prices over time as this occurs. As is often the case, this commoditization tends to benefit those whose networks are already in place and operational. They're much more able to compete purely on price than an operation such as CLWR still in a very early buildout stage. CLWR is a cash burning network buildout upstart that is operating in a sector whose product sold will continue to decrease in price due to competition.

Financials

$1.5 billion in cash post-ipo, $644 million in debt. While it appears here that cash minus debt is in the $5-$6 a share area, keep in mind CLWR's cash burn is massive. CLWR lost $1.75 per share in 2006, spent over $200 million in capital expenditures and a hefty additional amount on spectrum licenses. All told, CLWR's direct cash flow drain from operations/investment in 2006 was approximately $1.1 billion. Yes, $1.1 billion went out the door in 2006! This will continue to be a hefty cash burn operation for the foreseeable future as well. CLWR is really in the infancy of their planned buildout. Their financial situation on ipo looks fine, that will not be the case by early 2008 without an additional cash infusion. CLWR expects to burn through an astounding $5 a share in cash in 2007, which will actually be a bit of a decrease from 2006. This even assumes a doubling to tripling of revenues in '07. Expect cash per share (minus debt) to be closer to $1 per share by the end of 2007. This will mean CLWR will need more cash no later than the first half of 2008. Fully expect a pretty hefty dilutive secondary here sometime the first 12 months post-ipo. If market conditions allow, I would fully expect a similar size (20+ million shares) dilutive secondary as the ipo.

Note - CLWR founder as well as senior management have been very successful in the cellular phone business over the years. This is not a low risk ipo however. We've got a cash burning machine with little current market penetration planning on using an unproven technology. All that at a $3.864 billion market cap. In structure, this ipo resembles many of the fiber/wireless network ipos of 1999/2000. Some of those succeeded, many went bankrupt. Many of the ones that succeeded went through very dark days in 2001-2003. CLWR is a bet that some very smart people can pull off a high risk endeavor. A big factor here to me is the fat initial market cap for such a high risk venture still in relative infancy stage.

CLWR began their service in 2004. Revenues have grown strongly as CLWR has added service to communities and metro areas. 2005 revenues totaled $33 million. 2006 revenues tripled to $100 million. 2006 also marked the first year that CLWR experienced positive gross margins on their service and equipment sales. I would expect that trend to continue to get stronger as CLWR continues to expand. That does not mean CLWR is profitable however. While CLWR tripled revenues to $100 million in 2006, they also doubled SGA expense to $215 million. That disparity itself indicates CLWR is many years away from break-even. Expect that SGA expense line to continue to grow rapidly as CLWR advertises extensively in their coverage areas.

CLWR's losses are accelerating with their revenues. As noted above, expect that trend to continue over the next few years. Losses were approximately $1.75 per share officially in 2006. With 161 shares outstanding on ipo, that's a pretty hefty loss. Expect larger losses in 2007 and 2008. Cash flow drain will actually be more extensive for CLWR than the posted losses annually.

Revenues in 2007 should continue to grow strongly as CLWR expands their service. I would not be surprised if CLWR doubles or triples 2007 revenues to $200-$300 million. Much will depend on the timing of roll-outs. Note - CLWR sold their equipment segment to Motorola in the summer of 2006. They will no longer be receiving similar equipment revenues going forward. In 2006, approximately 35% of the revenues were from equipment sales. Going forward, the bulk of CLWR's revenues will be service revenues from customers subscribing to their Internet and phone plans. This could slow revenue growth a bit in 2007, however I would still expect revenue growth to be double or triple that of 2006. Regardless of revenue growth, do not look for anything but hefty losses here for the next few years.

Financially CLWR looks an awful lot like the network buildout ipos of 1999 and 2000. Note: 15% of CLWR's 2006 revenues appear to have come from related-party equipment sales in connection with a company controlled by CLWR founder Mr. McCaw. Similarly 15%-20% of 2005 revenues were also derived from related-party transactions with a company controlled by Mr. McCaw.

Conclusion

We'll start with the positives. 1) Senior executives with a solid track record in opening nationwide cellular communications networks. That is the driver of this ipo. CLWR's founder was instrumental in shifting cellular communications to a national voice network; 2) The financial backing of Intel/Motorola. Two strong partners. 3) A solid financial position on ipo. 4) A competitive product at a competitive price-point. I would use the Clearwire service were it available in my area.

Really, all things being equal, this would be enough to recommend this deal. However, all things are not equal here. CLWR is facing a slew of hurdles. 1) The cash burn rate figures to be enormous the next few years as CLWR builds out their network; 2) Competition is fierce. As CLWR spends to build out their network, the price points for broadband communication figure to shrink; 3) Dilution. Options and warrants alone figure to dilute those buying on ipo by 20% over the next two years. CLWR will also need more money. Expect a secondary in the first year. That will further dilute ipo holders by 10%+. That is 30% dilution for those buying the ipo. Fully expect CLWR's market cap in two years to be closer to $5 billion than $3.86 even if the price remains in the $24 ballpark. That is a hefty dilution for those buying ipo and for me trumps everything else.

Can CLWR be successful? I think it is possible. How much success is built in on a $4-$5 billion market cap? I would say more than a little. I've no idea really how this ipo will perform short or mid-term. For me though it really comes down to one factor: CLWR is coming public because they absolutely positively need the ipo money. I avoid ipos that come public out of a dire need for that ipo cash. It often bodes poorly for the long term prospects of that company. I'm passing on CLWR here. I realize there has been an awful lot of hype and attention on this ipo. There are just too many things here I do not like for this market cap. I wish Mr. McCaw and company well. I would use their product (if it were available in my area) but I won't be buying the stock.

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