Sprint Reports Mixed Results: Stay Away Until They Raise Capital

Oct.28.11 | About: Sprint Corporation (S)

On September 8th, I published an article called "Can Sprint Turn Things Around?". In the article, I questioned Sprint's (NYSE:S) ability to improve based on its deteriorating financial condition and continued losses. I said it was possible for the company to turn it around, but not likely at that point. They didn't have the iPhone at that point, so things going forward looked rather dim. After writing the article, I received emails and comments criticizing me for my position and weak analysis. My overall recommendation was to stay away from the stock. At publication, it was at $3.45. After a 7% drop today, it stands at just $2.51, down 27% from when I discussed the stock. Today, the company reported mixed results, and I am still recommending that you stay away from the stock for now.

The company recently reported third quarter results. Revenues rose 2% over last year's quarter to $8.33 billion, but this fell short of the $8.38 billion analysts were expecting. However, the company beat on the bottom line, a loss of 10 cents compared to the 22 cent expected loss. Here's the breakdown:

The Good News: There were a few good things in the report, first of all being the narrower than expected loss. Also, average revenue per user jumped by more than $3 year over year, the biggest jump in 12 years. The company also added 1.3 million net new subscribers, which was the best number in five years. The company also posted a $208 million operating profit compared to last year's $213 million operating loss.

It is a promising sign that the company has recently started posting quarterly operating profits. However, they are still losing money on the bottom line. When and if, and I mean when more than if, they return to profitability, they will have a nice amount of carry-forward losses that should keep their taxes low to zero for a while. But they need profits first. It's also positive that they are increasing subscribers at a nice clip. They need to continue that this quarter though, now that they have the iPhone. I'll be more of a believer when I see next quarter's continued improvement, but not until then.

The Bad News:

Gross profit margin declined from 44.88% to 44.67%. While this doesn't seem like a big drop, just remember how much they are paying to get the Apple (NASDAQ:AAPL) iPhone. It will likely continue to pressure these margins lower. Gross margins for the first nine months of this year were 45.22% compared to last year's 46.73% for the same period. That's a more noticeable drop. Operating cash flow also decreased from $3.35 billion for the quarter last year to $2.6 billion this year. They also lost 44,000 net subscribers, a number much wider than expected.

But the main reason I'm still cautious is that the company needs to raise money. In fact, they said today that they need another $7 billion. They are already paying about $1 billion a year in interest costs, and since they have over $16 billion of long term debt on the books already, one can only imagine that their interest rate will be higher than in the past, despite US interest rates being low. Many of Sprint's bonds already have interest rates in the 6-9% range, and I don't see how a new bond, especially of the size they need, will have anything less than that, if not more. They are currently trying to refinance and extend maturities of current deals, like the $2 plus billion due in March of 2012.

Sprint may be required to raise equity as well. Unfortunately, with the stock price at its lowest level in years, the market cap is only $7.5 billion. Anything more than a few hundred million would result in a massive dilution. But you wouldn't have interest payments tagged onto that capital.

Sprint is trying to improve its financial position, but some numbers aren't getting any better. In the first nine months of the year, their current ratio has declined from 1.252 to 1.126. Their overall cash balance is down $1.4 billion over that time to $3.76 billion. If their working capital and short term liquidity numbers continue to get worse, I'd really start to worry. Another troubling point is that their debt ratio (liabilities to assets) has actually improved from 71.84% to 72.84% so far this year. Luckily, those two ratios have stabilized a bit since the second quarter. But they need to improve going forward.

Sprint is going to need more financial flexibility to upgrade its network and get those iPhones. It did announce that it is trying to extend its current deal with Clearwire. That news sent Clearwire (CLWR) shares sharply higher today.

Looking Ahead:

When I wrote my first article on Sprint, the company was expected to lose about 83 cents a share this year. Before today, the current expectation was for a loss of 91 cents. The 12 cent beat in the third quarter should definitely help. But you're still talking about a $2.5 billion loss this year.

2012 probably won't be too much better. When I wrote that original article, the company was expected to lose about 68 cents next year. The current estimate calls for a loss of 92 cents. So much for earnings improvement year over year. In fact, it is likely that they will lose more money next year than in 2011. The expected loss for 2012 has nearly doubled in the past 90 days.

My Recommendation:

Sprint right now in the mid $2's is basically a long term option. But it's an option on the survival of the company. For the moment, there is no expiration date, but there is a time value premium that is eroding. It's the money the company is constantly losing, and if they are forced to raise equity, you are in trouble.

I would hold off on Sprint until we get a clearer picture of how they intend to raise this money they need, and if next quarter they say they need even more. Originally, the estimates were for $5 billion, so I wouldn't be surprised if they eventually need $10 billion. If you want to play this sector, you are better off in Verizon (NYSE:VZ) or AT&T (NYSE:T). Both provide nice dividends, and won't be dropping 27% in two months. Of course, you could also buy Apple, because Sprint's success will depend on the iPhone.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.