3 Reasons It Doesn't Matter If Sprint Buys T-Mobile

Aug. 8.14 | About: Sprint Corporation (S)

Summary

Postpaid customers are leaving.

Prepaid customers are leaving.

Debt is rising even without the rumored T-Mobile buyout.

Sprint (NYSE:S) investors might be interested in whether the company will buy T-Mobile (NASDAQ:TMUS). However, this company has serious problems, and even buying T-Mobile might not be enough to save the stock. The company's new "Framily" plans seem to offer a good value to customers, but customers are still leaving and Sprint's balance sheet is getting worse.

As the Framily Churns

Whether Sprint wants to promote its Framily plans with a hamster in a ball or the goth "Gor-don" doesn't seem to matter. Though its commercials are memorable, customers are still leaving. Looking at Sprint's postpaid customer churn rate compared to AT&T (NYSE:T) and Verizon (NYSE:VZ), there is clearly a problem.

Company

Postpaid Churn

AT&T

1.07%

Sprint

2.10%

Verizon

1.07%

Click to enlarge

Source: SEC filings.

With Sprint going head to head with its larger competitors every day for postpaid business, having a churn rate that is nearly double its peers is very troubling. If investors think that T-Mobile is going to save Sprint in this area, consider that in the last three months T-Mobile's postpaid churn was 1.5%. The first reason it doesn't matter if Sprint buys T-Mobile is that even the combined company would be losing postpaid customers at a faster rate than either AT&T or Verizon.

Customers Are Walking Away Here Too

The second reason it may not matter if Sprint buys T-Mobile is that the combined prepaid business looks weaker by the quarter. The simple truth of prepaid wireless is that customers walk away from prepaid plans easier than postpaid plans. The reason is that with no contract, if something changes there is nothing to tie the customer to Sprint or T-Mobile.

On the flip side, while AT&T and Verizon both offer prepaid plans, the vast majority of their wireless subscribers are on postpaid plans. We already know that these two huge companies have postpaid churn of nearly 1%; do Sprint investors think the company's prepaid churn of 4.3% in the current quarter is a good comparison?

The scary part is that Sprint's prepaid churn rate is rising. Last quarter the company reported prepaid churn of 3.22%. Again, if investors are hoping T-Mobile will make things better, its prepaid churn rate last quarter was 4.3%. With both companies showing a greater than 4% prepaid churn, competing against the more postpaid focused AT&T and Verizon is a questionable proposition at best.

Debt, Debt, and More Debt

Debt has been a huge challenge for Sprint for years and a big part of why Softbank's investment was such an important event for the company. However, Softbank may have to continue to support Sprint with more cash based on the rumored T-Mobile merger.

The third reason it may not matter if Sprint buys T-Mobile is that the company's long-term debt is growing even without T-Mobile. In fact, over the last year, Sprint's net long-term debt has expanded by more than 8%. This wouldn't be a huge deal, except Sprint reported core free cash flow (net income + depreciation - capex) of negative $340 million.

Considering that AT&T generated over $2.6 billion in core free cash flow, and Verizon produced over $6 billion, Sprint is already playing at a huge disadvantage. If T-Mobile is going to solve this problem, investors need to think again.

While the company does generate positive free cash flow, T-Mobile carries net long-term debt of $14 billion, and expects to spend at least $4 billion on capital expenditures in the next year. Given that Sprint would have to acquire T-Mobile and its debt, the company's debt balance is sure to balloon if this deal goes through.

Final Thoughts

The truth is, Sprint's customers are leaving in droves in both the postpaid and prepaid spaces. In an industry with AT&T and Verizon both concentrating on postpaid customers, and posting churn rates that are much lower, Sprint is already fighting an uphill battle.

If Sprint buys T-Mobile, not only will the company's balance sheet likely get worse, but the company's churn won't improve enough to compete with its larger peers. Investors may be excited about the combined company, but the facts say that there are several reasons it may not matter if Sprint buys T-Mobile.

Disclosure: The author is long VZ. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.