Shares of both Sprint (S) and Clearwire (CLWR) took a severe beating on Friday after Sprint publicly disowned its de-facto subsidiary Clearwire, of which it owns 54 percent, during the company’s 4G Strategy/Network Update held on Friday morning (conference call available here). Sprint announced that it would switch from using CLWR’s WiMax to power its 4G network to a Long Term Evolution (LTE) network that it will build itself. Furthermore, putting salt on CLWR’s wounds, Sprint announced it will stop selling phones and other devices compatible with CLWR’s current network at the end of 2012, as Sprint switches on its own 4G network.
The move had most analysts perplexed as to why Sprint would abandon its investment in CLWR, perhaps driving it into bankruptcy, while spending $6-$10 billion to upgrade its own network for 4G (to cover 250 million population), when it could accomplish the same by spending an additional $600 million in upgrading CLWR’s network (to cover 120 million population). And this from a company that is already highly levered with long-term debt of over $18 billion, and perhaps an additional $12 billion in cash flow commitments over the next four years to finance the purchase of 30.5 million of Apple’s (AAPL) iPhones, while its market-cap currently languishes below $8 billion. Some have expressed a lack of confidence in Sprint management, questioning the quality of the water they drink at their Kansas location. We think, however, that there may be a more reasonable, albeit sinister, explanation in that Sprint is hoping to drive down the value of CLWR assets, hoping to scoop up the entire company at a bargain.
Sprint management may have been caught flat-footed by the reaction of the investment community as it drove down shares by 17.4% to $2.47 on Friday, losing over $1.5 billion in market-cap. Company managers may have been expecting a more positive reaction to their recent strategic moves as they finally added the iPhone to the lineup, a move that will most likely help them stem subscriber losses to rivals AT&T (T) and Verizon (VZ), and possibly even reverse the losses due to Sprint’s unlimited data plan. Sprint shares have been in a tail-spin since topping near $26 in 2006, about the time when AAPL unveiled its first iPhone for release on AT&T’s network in January 2007. After four glorious years, the iPhone was also launched on rival VZ’s network in February 2011. Sprint, meanwhile, had been bleeding subscribers to its rivals due to the absence of the iPhone in its lineup.
We believe that Friday’s sharp drop in Sprint Shares is an over-reaction, fueled more by perplexity and maybe even disdain over the company’s moves and reticence in giving more detail during the company’s conference call. Although Sprint’s tide of losses since 2008 will not stop anytime soon, it trades at an attractive Enterprise Value / EBITDA ratio of 3.9, a price-to-sales (PSR) ratio of 0.27, and at 0.68x Book Value. The iPhone launch by Sprint could be a huge success, given the unlimited data plan offered by the company versus tiered data service offerings from its rivals T & VZ. Furthermore, the Network Vision Strategy could be a huge success at reducing costs due to lower tower maintenance and lower LTE chipset costs (versus WiMax). Sprint is likely to announce a diluting event in the near future to help finance its capital costs going forward, so we would wait to buy into the weakness that this event will create.
CLWR, on the other hand, is clearly in difficulty as it got dumped by its parent Sprint. The relationship has clearly been on the rocks for a while as prior to Friday’s announcement, there was some estrangement when Sprint announced in late July a 15-year spectrum hosting and network services agreement with LightSquared that effectively bypassed CLWR. In a telling sign, Sprint’s CEO Hesse indicated during the Q&A session after the conference call presentation when asked about why the company is risking losing CLWR spectrum in a bankruptcy, that, “no bankruptcy case involving a wireless company has resulted in a disruption of service.
CLWR owns attractive spectrum assets that some believe can fetch as much as $20 billion in an auction. At a current enterprise value of $3.6 billion, CLWR is clearly selling at a steep discount to that. However, Sprint’s move may have jeopardized the long-term viability of CLWR, pushing it into bankruptcy where interested parties may purchase its spectrum at fire-sale prices. Although there is still a possibility that a white knight may emerge, either buying out CLWR at a premium or striking a strategic partnership with it and funding the completion of its network deployment, we see vultures circling overhead ready to grab CLWR’s valuable spectrum assets for a bargain at a bankruptcy auction.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.