Clearwire Turnaround Plan Takes Next Step

Dec. 6.11 | About: Sprint Corporation (S)

Clearwire (CLWR) announced December 5 that it plans to sell at least $300 million of Class A Common Stock to the public (plus up to $45 million via the underwriters’ overallotment). In conjunction with the offering, Sprint has confirmed that they will invest $295 million in the company's Class B Common Stock, according to Bloomberg. I assume that Sprint will also participate pro rata if the overallotment is exercised, although this hasn't been confirmed. The total equity to be raised is at least $595, million and could be as much as $685 million.

This represents a critical next step in CLWR’s turnaround plan announced back in August. With the December 1 commitment from Sprint to be the anchor customer on CLWR’s planned LTE wholesale network, the company is now focused on raising the capital necessary to build the network.

Management has said previously that it expects to raise debt and equity in roughly equal proportions, so today’s announcement seems to imply roughly $1.2 billion of incremental financing, significantly more than the $900 million that management has said was required to build the network ($600 million) and provide working capital ($300 million). The key point here is that the total raise should be sufficient for CLWR to have a fully funded business plan, and may even permit them to expand the scope of the initial build plan.

Why Is This Good News?

Because it’s the logical (and critical) next step in the company’s turnaround plan. Management has been talking about raising equity and debt since August, and we now have some clarity on the equity piece. Management has spoken confidently about the debt portion, and I expect this to be announced fairly soon. Once the raise is behind them, it’s all about blocking and tackling – and we know this management team can execute in the wireless space as well as anybody.

What's The Catch?

In a word: dilution. Assuming the offering is priced at $2.25 per share, I estimate the dilution at approximately 22% based on shares outstanding, prior to the overallotment. This is a little worse than the 20% dilution I previously forecast, because the company is raising more money than I expected.

In addition, some investors may be concerned about the shorts piling in because they expect the company to raise equity at almost any price, but I think this risk is limited as explained later in this post. Given my belief that the breakup value of the stock is at least $8 per share, I think the dilution is a small price to pay for owning the stock at such an incredibly cheap level.

What About The Cable Companies?

I don't think anyone expects the cable companies to participate, given that they are bailing out of the CLWR relationship with their Verizon Wireless deal. I have to admit, though, that I'm still scratching my head on this one.

If you’re Comcast, why would you allow yourself to be diluted at a price that equates to $0.13 per MHz-Pop when you just sold similar spectrum to Verizon Wireless at $0.68 per MHz-Pop? Even if CLWR is no longer strategic for them (which, by the way, has been obvious for quite some time), the smart thing to do is write a small check for your pro rata share to avoid dilution, and hopefully sell your position down the road at much higher price. The cable companies are acutely aware of what CLWR’s spectrum is worth, and it seems crazy for them to stay on the sidelines.

So How Should Investors Feel About This Offering?

My support for CLWR is based on two fundamental principles: the value of its deep spectrum position in an increasingly bandwidth-hungry world, and the quality of management. I don’t think management is steering the company into a school of sharks (i.e. the shorts) just hoping not to get eaten alive. I think it's a safe bet that management has laid the groundwork and has a good idea of where the offering will be priced. I also think it will happen quickly – they wouldn’t announce an offering under these circumstances and then take weeks to price it.

The impact of the shorts should be muted anyway, because there is already a large short position in the stock, and given the underlying spectrum value and the ongoing success of the turnaround strategy the potential for a massive short squeeze is very high. Shorting a stock that’s already trading like an option is always dangerous, and even more so when the company has a strong management team that seems to be delivering as promised on its turnaround plan.

I believe the offering will happen quickly, at a price in excess of $2, followed shortly by an announcement regarding the debt financing. After that, I believe the stock is poised for a long climb as management continues to execute the business plan.

Disclosure: I am long CLWR.