Newsletter Value Investor Insight carried an interview June 30th with Legg Mason Value Trust Manager Bill Miller:
No grass has grown under the feet of Sprint Nextel CEO Gary Forsee since Nextel completed its merger with Sprint last summer. In addition to starting to integrate two large, complex businesses, Forsee spun off the company's local wireline business, partnered with four leading cable companies to offer wireless services to their customers, spent billions to start buying in independent regional affiliates and rolled out a wide variety of content data services with partners such as ESPN.
The market's response to all this activity? Calling it a big yawn would be generous. Adjusting for the value received in the wireline spinoff, Sprint Nextel shares, at a recent $19.93, are down 16% since last year’s August 12th merger close.
That’s been bad news for Legg Mason’s Bill Miller, who recommended Nextel to us last summer (VII, June 19, 2005) after the merger had already been announced. Citing unrecognized longterm upside from the changed economics of a consolidating wireless industry, growth in new cellular services and merger- related operational improvements and cost savings, he felt Nextel was “among the cheapest big companies in America.”
Miller’s response to the flagging share price? “We bought more,” he says. “Other things held equal – and we think they still are equal here – if the price goes down, our implied rate of return goes up.”
Companies often go into the market's “penalty box” after big mergers, says Miller, when integration benefits are not immediately evident. “The market seems to expect pure linearity in what John Templeton used to call 'outlook and trend,' meaning near-term movements in margins and operating ratios,” says Miller. “We stay focused on value and valuation and – barring a significant deterioration in a company’s competitive position – generally find this type of fixation on outlook and trend to be irrelevant.”
More relevant to Miller is that Sprint shares, based on his estimates, now trade at a 2006 enterprise-value-to-EBITDA multiple of only 5.5x, falling to 5.1x on 2007 numbers. It makes no sense, he says, that a business of Sprint’s quality – subscribers continue to grow, EBITDA should grow 10% per year and EBITDA margins are high (35%) and expanding – trades at a significant discount to the 8-9x multiples at which other subscriptionbased, but far less attractive, businesses such as newspapers trade. Even shares of Embarq, Sprint’s no-growth wireline spinoff, trade at the same multiple as its former parent.
How cheap is Sprint at the current price? “Spreads in valuations between industries are among the lowest we’ve seen in the past 50 years, so you see a lot of things that, at most, appear to be 10- 15% mispriced,” Miller says. “In contrast, with Sprint I think the private market value is conservatively 50% above today’s price and could be double today's price under decent conditions going out a couple of years.”