Fleet Thinking Helps Tiny Nextel Make Big Waves : Telecommunications: The maker of low-tech radio dispatch equipment aims to create a national system to rival cellular’s.

When people think of telecommunications these days, they think of giants: Motorola. AT&T.; NTT. Nextel.

Nextel? With $9.6 million in losses on just $53 million in sales last year, the Rutherford, N.J., company is a mere skiff among the supertankers of the communications world.

But incredible as it may seem, the skiff is making waves. In a shifting seascape where strategy is often more important than size, Nextel is the key player in an ambitious drive to create the nation’s largest wireless communications network.

A maker of radio dispatch systems used by taxis and buses, Nextel has won crucial backing from Motorola, Northern Telecom and others in its quest to transform its blue-collar radio system into a national mobile-phone service.

In January, Nextel will have the first piece of its strategy in place when it begins offering customers in Los Angeles portable handsets that can be used not only by traditional dispatchers as two-way radios, but also as cellular phones, pagers and even receivers for electronic mail.

Already, the stock market is valuing the company, which has little more in assets than a portfolio of radio licenses, at an astounding $7.15 billion.

Nextel’s is a story of how a small company can use technology and strategic alliances to transform itself into a force capable of shaping an entire industry. Ironically, its tale of grasping at hidden opportunity and building strategic alliances mirrors that of one of its key rivals: McCaw Cellular.

Nextel’s story begins seven years ago, when Morgan E. O’Brien, an attorney who had spent nine years at the Federal Communications Commission and subsequently represented companies involved in the mobile-radio business, made a curious observation.

Licenses for radio frequencies used by taxi dispatchers, he realized, could be purchased for a fraction of the price of cellular licenses that used the same frequencies.

The reason? The radio frequencies were broken up into thousands of tiny pieces, each of which was too small to use for anything much beyond radio dispatching in a limited metropolitan area.

O’Brien figured that by buying up enough radio dispatch licenses in major cities around the country, combining them and applying the latest technology, he could use the frequencies in the same way cellular phone companies do.

Traditionally, mobile-radio users send out strong signals from transmitters on hilltop locations, enabling a voice on a frequency to be heard anywhere in that territory. Cellular technology, by contrast, uses lots of low-power transmitters in a “cellular” architecture, with each cell connected to a central switch. This allows many more customers to communicate on the same frequency at the same time.

O’Brien figured he could go one better by creating a single national network using standard digital technology. That would make it possible to travel almost anywhere in the country using the same handset, yet with far fewer instances of fade-out--the bane of the cellular phone.

“I had an unshakable faith that with an idea this powerful we would win,” says O’Brien.

When an investment banker sought a reaction to O’Brien’s proposals from Brian McAuley, then a senior vice president at an East Coast cellular company, McAuley was intrigued. The two joined to create a company they initially named Fleet Call--with McAuley as chief executive and O’Brien as chairman--and began quietly buying up licenses in such major cities as New York and Chicago. In Los Angeles, one of the largest and most congested markets for cellular phone service, Nextel began buying up mobile-radio licenses as early as 1987.

“In a war, you need to control the high ground,” says John L. Bauer, telecommunications analyst at Prudential Securities. “In cellular, you have to control the urban markets.”

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The technology for radio dispatch services was so old, its capacity so limited and the industry’s profit margins so small that there was little competition for the properties. “Everybody wondered what we were doing paying so much for these licenses,” says McAuley, chuckling at the memory.

When they had purchased licenses in the key markets, the two executives took a calculated gamble. They arranged a secret meeting with Motorola’s then-chief executive, George Fisher, to outline their strategy.

They knew that Motorola--which manufactured many of the outdated radio systems then in use and held rights to thousands of frequencies across the country--was potentially a powerful ally. But they also knew that the company could be a ferocious rival.

“We didn’t know how they would react,” recalls McAuley. “They might look at us as a threat or as an opportunity. So we went straight to the top with our plans.” But even Fisher was kept in the dark as to the names and business interests of his visitors.

The gamble paid off. The meeting, held Feb. 14, 1990, created a close partnership that proved critical to Nextel. Motorola had been in the process of developing a new generation of equipment that used digital, computer-type signals to vastly increase the capacity and feature offerings of mobile-radio systems.

Motorola saw Nextel as a potential customer that could help establish a nationwide standard. Motorola not only promised to provide the equipment but also loaned the company hundreds of millions of dollars to help finance its growth.

In addition, Motorola backed Nextel’s application to the FCC for permission to use cellular technology on its frequencies. And it used its international connections to provide critical introductions.

It persuaded Matsushita Electric, Japan’s largest consumer electronics company, to invest $45 million in Nextel and become a second supplier (along with Motorola) for the handsets for Nextel’s system. Motorola and Nextel recognized that without at least two companies competing for the handset business, the technology couldn’t keep pace with cellular phones in price and size.

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Nippon Telegraph & Telecommunications, Japan’s telephone monopoly, invested $75 million in Nextel and offered to use its networking expertise to help Nextel stitch together its national network. And Northern Telecom, Canada’s telecommunications giant, provided $40 million in financing to help Nextel buy NTT’s state-of-the-art telephone switches.

Motorola and Nextel also began building alliances with other mobile-radio service providers.

Nextel handed some of its radio licenses over to Cencall Communications, a company with a strong position in the Pacific Northwest, in exchange for a 37% share of Cencall. Motorola sold licenses that helped Dial Page, another mobile-radio operator, build a strong position in the South in exchange for a stake in Dial Page. Each agreed to use Motorola technology.

The crowning deal came last month, when Motorola sold all of its radio licenses to Nextel in exchange for a 20% stake in the company, a deal valued at about $1.8 billion. When combined with the 125 other deals Nextel had already completed, worth a total of about $1.2 billion, Nextel had accumulated enough radio frequencies to cover a potential customer base of 180 million people in a nation of some 250 million.

“There is no other wireless carrier that can cover that kind of population,” says Jeffrey Hines, a telecommunications analyst at Paine Webber. “It’s an exciting company.”

The return on investment could be phenomenal. The company figures that with its new equipment in place, it will be able to carry 180 customers on a channel previously reserved for a single customer.

“We’re leapfrogging the cellular companies,” says McAuley. He expects Nextel to cover all of California by the end of 1994 and most of the country by 1996. The company plans to spend more than $1.5 billion over the next two years to install the necessary equipment.

Some analysts see big money to be made with Nextel.

Bauer of Prudential notes that Nextel shares are selling for $33 a “pop,” or potential customer, compared to $217 a pop for McCaw Cellular shares. (McCaw is in the process of being acquired by AT&T.;) Assuming that the gulf narrows, says Bauer, the stock could triple.

Skeptics question whether Nextel can move quickly enough to compete with well-heeled cellular companies and the horde of new firms expected to enter the wireless business by buying up licenses at an FCC auction next year. Such bears have contributed to the stock’s fall from a recent high of $53 to the current $40.25.

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One potential problem: The Motorola technology Nextel is depending on is still largely untested.

“They are on the burning edge of technology,” says Herschel Shosteck, an economist specializing in the cellular industry, who wryly notes that new technology has a tendency to burn its first users.

And Nextel faces fierce competition from cellular companies that already have an extensive distribution system, a $14-billion investment in equipment and powerful marketing arms.

“They have miles and miles and miles to go before they sleep,” says McCaw Cellular spokesman Robert Ratliffe. His firm, Ratliffe says, will soon announce many of the services Nextel is promising. “Our system is up and operating,” he says. “They won’t have anything we can’t offer.”

Nextel doesn’t plan to go head-to-head with the cellular companies right away. It will begin by competing with them on the turf where it’s strongest: users of radio dispatch equipment, most of whom also carry cellular phones and pagers.

Nextel figures these radio dispatch customers will find they will pay less by getting all three services from one provider and having less equipment to carry around. “Customers don’t want three pieces of equipment,” says O’Brien.

Even this market is enough to give cellular phone companies a major headache. In the Los Angeles area alone, there are 550,000 users of such two-way systems, from pizza delivery services to tour companies. Nationwide, there are 16 million radio dispatch units in use, compared to 14 million cellular phones.

And, to the extent Nextel is moving more quickly than its cellular rivals to install digital equipment, it will have an important edge on the kinds of services it can offer.

While fire and police services in many regions can’t talk to each other because they use incompatible systems, for example, a switch to Nextel would allow various agencies involved in fighting a fire to speak together simultaneously at the push of a button. The system, because it is digital, could also receive computer information that would keep firefighters updated on available water supply at different locations.

A manager who wanted to tell hundreds of scattered salespeople about a price increase could simply type the message on a personal computer. The message would instantaneously appear on little screens in the portable telephones of the sales force virtually anywhere in the country. Investors could have their handsets programmed to receive hourly updates on the price of a given basket of stocks.

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Even without a working system in place, Nextel is proving to be an important player in the cellular market. Shosteck gives Nextel credit for the decision this summer by L.A. Cellular and Pacific Telesis to cut their cellular rates by as much as 20%.

“You’re going to see the same thing in the mobile business that happened in the long-distance area when MCI entered the field,” he says.

For a small company, Nextel has also attracted some big talent. Many of its top executives come from rival McCaw Cellular. Through one of its deals, a recent merger with Powerfone, Nextel brought onto its management team Mark Fowler, former chairman of the FCC in the Ronald Reagan Administration.

“We will have the best wireless communications network in America,” says Chairman O’Brien. To those who accuse him of hyperbole, he responds: “We are the impossible company. At every step, people said we couldn’t do it, and one after the other we’ve overcome the hurdles.”

Nextel at a Glance

* Business: Nation’s largest “mobile radio” provider, holding licenses to parts of the spectrum that can--and will--be used for cellular phone service.

* Coverage: 180 million people, including Los Angeles, New York and Chicago

* Headquarters: Rutherford, N.J.

* Employees: 615

* Shares outstanding (includes warrants, etc.): 177.7 million

* Stock Price: $40.25

* Market Valuation: $7.15 billion

* Sales (12 months ended in March): $53 million

* Loss: $9.6 million