By Marshall Hargrave
Clearwire Corporation (CLWR) is up almost 25% over the past month on speculation that Sprint Nextel Corporation (S) might buy the remaining 49% of shares in CLWR stock it does not own. Very prominent and notable billionaires were upping their stake of Sprint last quarter, such as Ken Fisher (+95%), D.E. Shaw (+66%), and Jim Simons (+26%), following Softbank's announcement of plans to invest $20 billion in Sprint in return for 70% ownership. David Einhorn -- founder of Greenlight Capital -- remains one of Sprint's largest shareholders (see David Einhorn's newest picks).
The $20 billion investment by Softbank will be split between shareholders and acquisition capital for the company. Around $12 billion will be paid to Sprint shareholders, with $8 billion left to the company for the purpose of strategic acquisitions. Our initial fear -- that Sprint's network upgrade plan would cause a cash drain over the next couple of years -- is now somewhat alleviated. Sprint also recently raised over $3 billion with the sale of convertibles. Softbank's investment bodes well for the wireless provider, which should help boost the company's ability to acquire strategic spectrum assets and build its network, all in an effort to better compete with top carriers AT&T, Inc. (T) and Verizon Communications, Inc. (VZ).
The possible Clearwire acquisition has become an even greater reality following the capital injection by Softbank. Sprint continues to be Clearwire's largest shareholder and with complete control over Clearwire, Sprint would have free reign over the broadband company's spectrum. A Clearwire acquisition would help Sprint buildout its LTE and 4G network, while hedging the upcoming closure of the Nextel network in mid-2013. Billionaire George Soros was one of Clearwire's newest big-name owners last quarter (check out George Soros' key stock picks).
Sprint saw revenues up 3.4% in 2011, and is expected to produce a sales increase of 4.3% by the end of this year. Sprint is expected to continue to grow revenue modestly over the next couple years as it facilitates the build out of LTE and 4G networks. With these initiatives, the company hopes to slow the bleeding of subscribers, and operating losses are expected to narrow from $1.42 a share in 2012 to $0.61 next year.
Sprint's top competitors have been outpacing the company in terms of aggregate subscribers, but the real battle remains for spectrum. Verizon recently purchased spectrum from multiple cable companies, while AT&T purchased assets from Qualcomm (QCOM). AT&T was forced to abandon its acquisition of T-Mobile, the subsidiary of Deutsche Telekom, and as a result, we believe that Verizon now has a distinct advantage over AT&T in the so-called "spectrum battle."
Although AT&T has a more robust dividend yield of 5.3% compared to Verizon's 4.6%, we believe that the latter is a much better 'growth at a reasonable price' investment. Billionaire investor and long-time Forbes columnist Ken Fisher is one of AT&T's largest owners (check out Ken Fisher's latest picks).
Verizon and AT&T trade in lockstep on many measures, including beta, P/E and profit margins, but digging deeper into the valuation, we find that Verizon lags in other metrics for no apparent reason. Verizon trades at only 1.1x sales and 6.6x cash flow, while AT&T is at 1.6x and 8.8x cash flow. This is especially puzzling when you consider the long-term growth rates of the two companies, where Verizon is expected to grow earnings twice as fast -- at 12% annually -- over the next five years compared to AT&T.
Sprint continues to post negative earnings, making it difficult to value on a conventional earnings basis. On a P/S basis, Sprint trades at a hefty discount to its peers, and even a discount to U.S. Cellular Corporation (USM). U.S. Cellular only operates in 26 states and is expected to grow long-term earnings at 5% annually, but manages to yield higher valuation metrics than Sprint. Sprint's P/S ratio is currently at 0.5x, while U.S. Cellular trades at 0.7x.
Assuming that Sprint gets some earnings stability thanks to acquisitions using Softbank's invested capital -- including the possible Clearwire acquisition -- its shares should easily trade more in line with peers, and a 0.7x P/S on next year's sales puts the stock's upside at nearly 50% from current levels.