by David Sterman
With the proper focus, it's sometimes possible to see a business headed for trouble long before it occurs. Last summer, I told readers wireless service provider Clearwire Corp. (Nasdaq: CLWR) was in deeper trouble than Wall Street analysts were publicly conceding. The analysts were carrying "buy" ratings, even when the business was starting to collapse. Since I looked at the stock, it has fallen nearly 80% in just 14 months. And from where I sit, a bankruptcy is almost certain. Let me explain...
In 2010, I noted Clearwire had been making a major bet on the WiMax technology (worldwide interoperability for microwave access) to deliver 4G mobile wireless speeds. The trouble was telecom engineers were increasingly convinced that a rival technology -- LTE (long-term evolution) -- was even better, since it could handle larger volumes of data at faster speeds. Clearwire's management acknowledged that growing sentiment, which immediately raised the question of why the company had borrowed and spent billions of dollars in support of WiMax.
In 2011, things got messier. Clearwire had always counted on generous financial support from its largest customer, Sprint Nextel (NYSE: S). (Sprint has made serial capital injections in Clearwire and now owns 48%, controlling 54% of the voting stock.) But Sprint has begun to express regret about pinning its 4G hopes on Clearwire's network. Once Sprint started to make its own 4G network -- using the stronger LTE technology -- it was almost a matter of time before it announced a public divorce. In a meeting with analysts on Friday, Oct. 7, Sprint said it would soon stop selling phones that work in conjunction with Clearwire's 4G network. This caused Clearwire's stock to fall 30% that same day. And the selling may just be beginning...
A transition to... what?
Clearwire probably saw this coming. The company had announced plans earlier this year to place LTE technology right on top of its WiMax network. Management figured the upgrade would cost just $600 million -- a mere pittance when compared with the nearly $6 billion that has been poured into the business. Clearwire hoped that would be enough to mollify an increasingly displeased Sprint, which has grown tired of writing more checks to support Clearwire while tackling financial challenges in its own business. And Sprint, apparently, has had enough. It will solely focus on its own business in 2012 and beyond (the company has an agreement to pay for the use of Clearwire's network through 2012).
Where does this leave Clearwire? The company had 7.7 million customers at the end of the second quarter, of which 80% came through Sprint's enterprise-level relationships. Clearwire has also been pursuing retail customers through its direct sales efforts (at a cost of about $300 per subscriber in marketing expenses). This summer, management spoke of a full-year target of 10 million customers. But now, after Sprint's announcement, it's not clear how Clearwire intends to draw the additional 2.3 million customers. In addition, the retail wireless business is fiercely competitive, which is why other Clearwire partners such as T-Mobile are also looking for an exit strategy.
In the wireless telecom business, it's not just about the customers you attract, but the customers you don't lose. Many companies that have services with Clearwire may now conclude it's simply safer to switch over to a firm like Verizon Wireless (NYSE: VZ) or AT&T (NYSE: T), now that Sprint is no longer fighting on behalf of Clearwire,. You can be sure sales teams at these firms will be asking potential clients "Are you really sure Clearwire will be around in a few years?"
That's actually a good question.
Left solely to its own devices, what kind of business can Clearwire build? And will its debt-laden balance sheet hold up in the weight of further capital-spending requirements? As it stands now, Clearwire's cash flow and spending trends will be without any more funds by next June. Clearwire has already spent $5 billion on capital expenditure in the past three years, and likely still needs to spend another $1 billion to complete its network development. The company has announced plans to raise even more money -- either in stock or debt -- but the Sprint announcement makes this a lot harder to materialize. Without Sprint as a partner, investors and lenders will now question Clearwire's viability.
Analysts at Merrill Lynch, in a just-released report, put it most succinctly:
"Based on work with our high-yield research group, we believe Clearwire has effectively exhausted its secured debt capacity and with the second lien bonds trading at <$0.60, unsecured financing is not a practical option. Equity capital markets are similarly closed, in our view. Sprint has been viewed as a funder of last resort for Clearwire based on the strategic value of Clearwire's 4G network to Sprint, but today's comments cast further doubt, in our view."
Merrill's analysts have a new price target of just $0.50 for the stock, which is well below the current $1.40 price. The reason the stock may not go all the way to zero: Clearwire holds valuable wireless spectrum. But what it would be worth, after debts are repaid, is unclear. Regardless, it appears as if shares would slowly lose steam and drop further form here as the implications of a divorce from Sprint become fully digested.
Risks to Consider: Clearwire's weak position has left it quite valuable to a strategic or financial investor that wants to acquire all of the invested assets on the cheap. So the emergence of a white knight is the biggest risk to shorting the stock.
Death spirals often play out the same way. Cash needs to be conserved and growth ambitions get curtailed. Without planned-for growth, financial targets can't be met, bondholders grow skittish and the corpus of the enterprise gets cut up in bankruptcy court. Unless something changes, this is what may well happen to Clearwire, wiping out equity holders in the process. Before this happens, you should sell this stock now if you own it -- or think about shorting it if you don't.
Disclosure: D. Sterman and/or StreetAuthority, LLC hold a position in NYSE:VZ, NYSE:T, NYSE:S, NASDAQ:CLWR.