According to our valuation methodology, the telecom sector has begun to look more underappreciated of late. In fact, as of this week we see that sector as having the second most attractive valuation behind Healthcare (which comes with potentially significant regulatory risks). More specifically, Sprint Nextel (NYSE:S) has become one of the more interesting stocks to us in the telecom sector, as it finally appears to have some things headed in its direction. The last time we wrote about Sprint was in early March after their CFO spoke about their plan to reignite growth as well as their ability to get serious about paying down debt (Sprint Sees Growth Ahead and Vows to Get Aggressive on Debt). Over the next two and a half months Sprint vaulted more than 60% while the rest of the market of US stocks slipped nearly 6%. Although, over the last month the stock has reversed fortune falling almost 13%, a rate that was nearly six-times worse than the overall market during that time. What is an investor to make of the situation?
At Ockham, we have seen Sprint as Undervalued for quite some time, and to this point that has not been a very accurate call. However, we do see reason to believe that the stock that fell out of favor long ago, may benefit from a shift in perception and better execution.
- Pre-Paid Growth: With the huge demand for smartphones that bind users into long term contracts, it may be surprising to some that the fastest growing segment in mobile is actually prepaid. Sprint owns two of the largest names in prepaid wireless service: Boost as well as Virgin Mobile through a recent acquisition. As Sprint has lost ground to AT&T (NYSE:T) and Verizon (NYSE:VZ) in postpaid subscribers for the last few years, they have relied more heavily on the prepaid business and that may turn out to be a key driver of growth going forward. In 2009, revenues from its prepaid business grew impressively 39% thanks to the strong additions in from Boost. Prepaid plans offer cost-conscious consumers a cheap option and now come with many of the same bells and whistles as a postpaid plan (voice, text, and data) without the commitment of a contract. We think this will continue to be an important source of revenue growth for Sprint, as they continue to grow market share and were up to 10.7 million prepaid customers as of the end of 2009.
- New Hot Devices: The iPhone has been a thorn in the side of Sprint ever since it came out, and they may only worsen as AT&T loses exclusivity and it becomes available on Verizon in 2011. However, Sprint thinks that they have an ace in the hole in the HTC EVO. The EVO launched in early June and Sprint stores have struggled to keep the devices on shelves, and management said they have been surprised by the greater than expected demand. Part of the reason is that the Android-based smartphone is the first to offer a 4G network, but also operates on 3G where 4G is unavailable. The features of this phone are impressive and too numerous to list, and initial reviews have been largely positive. Sales results have not been released yet and we would not expect iPhone type numbers, but we think Sprint finally has a device can stand up next to the other elite phones on the market. It has been lacking a must-have device like this for some time, and Sprint hopes the EVO and a new 4G phone to be released soon from Samsung may anchor subscriber growth.
- Reversing Churn – As anyone who has watched Sprint over the last few years knows, perhaps their largest problem has been churn in their postpaid wireless business. In other words, customers have been leaving Sprint, often in favor of their bigger rivals. Sprint has undertaken initiatives to stem the churn and the trends have started to improve, although growth remains elusive. With that said, they have gotten very aggressive on pricing offering $69 plans that provide unlimited voice, text and data. Not only is it cheap, but it is simple to understand which customers appreciate. That is a tremendous value compared to their rivals and it may be too good for many consumers to ignore. Those plans along with the excitement surrounding some of the aforementioned phones should help reduce churn in their postpaid business.
- 4G – Lastly, Sprint is the first US wireless carrier to roll out a 4G network. This network will allow increasingly data hungry consumers to speedily surf the web and read emails on their phones. While it has taken a substantial investment (partially through its alliance with Clearwire (CLWR)) and will certainly take further investment down the road to expand it to more places, we think it is usually a good thing to be a leader in technology. Devices like smartphones and laptop connect cards are great, but they are worthless without a network to run them on. In this respect, Sprint is at the head of the class.
Of course it is not all roses with Sprint as they have a relatively high debt load, and they cannot command as much margin at their pricing level. Yet we think Sprint is attractively priced at current levels and thus we are reiterating our Undervalued rating on shares. The turnaround effort that Sprint management has undertaken has been a long and often painful process, but now more than ever we are seeing a light at the end of the tunnel. If Sprint is going to start making significant steps forward, it will likely have these four catalysts to thank.