Clearwire: At Long Last, Positive EBITDA And LightSquared Collapse Confirm Deep Value

| About: Sprint Corporation (S)

Since soaring to a recent high in December, Clearwire (CLWR) shares have steadily fallen, recently trading at around $1.80. That is a fall of nearly 30% in just over a month's time. We have received a good deal of messages regarding this, and as such we would like to address the concerns about Clearwire.

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We have discussed Clearwire at length in several previous articles, including one about how deeply the company is undervalued, and about how its ownership structure presents a unique opportunity for retail investors.

Recent News

Clearwire shares have slowly but steadily drifted lower from their December highs, yet there has been no material negative news in the past month. The following 2 items have been the only operational announcements from Clearwire:

  1. Network testing agreement with China Mobile (NYSE:CHL): On January 17, Clearwire announced that it will be jointly testing 4G networks in the US and China with China Mobile, the world's largest wireless company. The goal of these tests is to have 4G networks in China compatible with the 4G standards that Clearwire will use here in the United States.
  2. Simplexity deal: Just this morning, Clearwire announced that it has signed a wholesale services deal with Simplexity, a MVNO (mobile virtual network operator). Under the terms of the deal, Simplexity will have access to Clearwire's 4G spectrum to resell it to its own customers. While it is good to see that Clearwire is working to generate revenue from sources other than Sprint (NYSE:S), the more important aspect of this deal is that Simplexity is also a LightSquared customer. While Simplexity has stated that it remains a partner of LightSquared, what would be the purpose of signing a deal with Clearwire if LightSquared will launch its network anytime soon?

While these are good developments for Clearwire, they are not that material to the company, at least in the short-term. What is material, however, is Clearwire's announcement of preliminary fourth quarter results on Tuesday, January 24. Clearwire expects revenue of $362 million (another record), on the back of soaring subscriber additions. The company reported net wholesale subscriber growth of 900,000, and ended 2011 with about 10.4 million subscribers, representing annual growth of 140%. Usage increased 22% from the third quarter, and grew 165% in 2011.

But what is more important is that Clearwire estimates that fourth quarter adjusted EBITDA will be positive, due to growing revenue and tight expense controls. While the company did not put a precise number on that, full results will be announced "in the coming weeks." Clearwire's potential is finally being realized, and positive EBITDA is a stepping stone to full profitability, something that Clearwire is sure to achieve. While we caution investors from assuming that a single quarter of positive EBITDA will make up for the billions in red ink, it is nevertheless a great sign that Clearwire can succeed. Clearwire's results included news that the company used just $82 million in cash this quarter, when interest payments and cash from its stock offering are excluded. That represents one of the smallest operational cash burn rates in the company's history, and the Clearwire is on the right trajectory. We fully believe that the company can post positive cash flow in 2012.

Continuing to execute on the capital raising plan announced in December, Clearwire, in announcing preliminary fourth quarter results, also announced that it is offering $300 million of debt backed by Clearwire Communications. Clearwire's offering of debt should not be viewed with alarm, for it has been telegraphed by the company and is a necessary step in the company's rebuilding of its network from WiMax to LTE.

Clearwire shares have been battered in 2011 by a variety of factors, including funding concerns and LightSquared growing relationship with Sprint. We have addressed in detail issues surrounding the company's finances in previous articles. But what we have not addressed in detail is the company many see as Clearwire's primary competitor: LightSquared.


LightSquared is, in some ways, very similar to Clearwire. Both companies are a collection of spectrum assets currently backed by other companies (Sprint and Harbinger Capital Partners (NYSE:HRG)). But, that is where the similarities end. Clearwire has a viable network, and LightSquared will most likely never see the light of day. Concerns over LightSquared have pressured Clearwire stock in 2011, yet an examination of the dynamics surrounding LightSquared show that Clearwire investors have little, if anything to fear.

Few companies face as much opposition in Washington and the private sector as LightSquared. Agencies all over Washington, such as the FCC, FAA, NASA, the Department of Commerce, the Department of Agriculture, and the Pentagon, are opposed to letting LightSquared commence operations. So are dozens of members of Congress.

Why? It is because the spectrum LightSquared plans to use for its networks sits very close to the spectrum used by GPS devices, and has been shown to cause interference with a variety of devices. LightSquared has fought these charges vigorously, claiming the tests are rigged and do not reflect real operating conditions. Frankly, whether or not that is true is irrelevant. Government regulators have discretion in this matter. LightSquared can argue all it wants about the validity of these tests, but the government has every right to carry them out according to the parameters it wants. Drug companies have no right to complain that the FDA's clinical trial demands are too strict. A company can be as satisfied with its own test results as much as it wants to, but it regulators do not approve of them, then that is the end of the discussion. It is true that LightSquared's own internal testing has shown that interference is either at minute levels, or non-existent, but what matters is what the government believes. As unfair as that may seem, it is the reality of the situation, and none of the regulators standing in opposition to LightSquared have shown any signs of softening their stance, no matter what the company does.

Everyone can agree that avoiding GPS interference is essential, in terms of both America's economic prosperity and national security. The FCC has consistently blocked LightSquared from launching precisely because its network has been shown to threaten the GPS system. As test after test has shown LightSquared's network interferes with GPS devices, the company has taken to arguing that the GPS industry is rigging the tests in its own favor.

Let us then approach that issue in the most cynical way possible. The Coalition to Save Our GPS has been the most vocal industry opponent of LightSquared and its network, on the ground the network will do enormous damage to the GPS industry. A look at the coalition's membership list shows a variety of smaller industry associations, some governments, and a collection of large public companies. We will focus on those public companies. Public companies, no matter their industry or focus exist for one end goal: to generate profits for their owners (investors). Thus, everything a public company does is done through the prism of increasing earnings per share. Thus, it stands to reason, at least to LightSquared, that lobbying to block its network would result in higher profits at the companies opposing it. Given that public everything a public company does is to increase its earnings, surely the non-existence of LightSquared's network will result in higher profits. However, a look at which public companies make up the Coalition to Save Our GPS would show that this theory makes little sense in reality. The major public companies that are members of this coalition are: FedEx (NYSE:FDX), UPS (NYSE:UPS), Delta (NYSE:DAL), Southwest (NYSE:LUV), Caterpillar (NYSE:CAT), Agco (NYSE:AGCO), Deere (NYSE:DE), TomTom, Garmin (NASDAQ:GRMN), and Trimble (NASDAQ:TRMB).

Even a cursory glance at this list shows that there are no direct competitors to LigtSquared working with this group. No Clearwire. No AT&T (NYSE:T). No Verizon (NYSE:VZ).

There is however, the USA Rice Federation. What possible financial benefit could the USA Rice Federation receive if LightSquared's network never sees the light of day? As for the public companies on that list, it is unreasonable to assume that they will profit from a lack of another wireless network. Delta and Southwest will not gain extra passengers by blocking LightSquared. Nor will UPS and FedEx ship more packages. Profits for Caterpillar, Agco, and Deere are determined by how much demand exists for agricultural equipment, not how many wireless networks there are in the United States. Even the GPS companies in the trade group (Garmin, TomTom, and Trimble) would not see a benefit from blocking LightSquared from operating other than the fact that their devices will not fail due to interference. There is no direct financial benefit to blocking LightSquared.

LightSquared's troubles extend beyond the operational side, however. Like Clearwire, LightSquared is burning cash and has needed to resort to constant injections of cash. LightSquared's Sprint is Harbinger Capital Partners, the hedge fund run by billionaire Phillip Falcone. LightSquared is projected to run out of cash in the first half of 2012, based on current estimates. The key difference between Clearwire and LightSquared in this aspect is that Harbinger is limited in how much more in can invest in LightSquared to keep it afloat. Harbinger already owns almost 100% of LightSquared, and more than half of his hedge fund's assets are invested in LightSquared, essentially violating the very definition of a hedge fund and angering his investors in the process. Harbinger faces a cloud of political uncertainty. The fund is under SEC investigation for a number of violations, including preferential treatment of Goldman Sachs (NYSE:GS), bond market manipulations, personal loans taken out from the fund, and "violations of the federal securities laws' antifraud provisions." Further compounding Harbinger's problems is a potential revelation that Phillip Falcone may have offered to put a LightSquared call center in Iowa if Senator Charles Grassley dropped his opposition to the wireless network.

Recently, information has surfaced that Carl Icahn, the famed corporate raider and activist investor, has bought some $300 million of LightSquared debt, positioning himself to profit from a potential LightSquared bankruptcy. While no investor has a perfect track record, betting against Carl Icahn has historically been a losing proposition. Icahn has executed this maneuver many times before, and would not have done this if he did not believe the bonds would work in his favor, presumably through a bankruptcy sale of LightSquared's assets.


Clearwire shares have dropped steadily over the past month or so on no material negative news. Some have suggested this is occurring because Class B stockholders are converting into Class A shares, thus pressuring the publicly traded A shares. However, since the SEC does not require reporting of such a transaction, there is no way of knowing for sure. Others have suggested that short-sellers are pressuring the stock to cover their shorts in a more profitable way, having caught on that Clearwire is undervalued.

Given the troubles facing LightSquared, Sprint's role as Clearwire's patron is safe until the time comes when Clearwire does not need it. Clearwire's preliminary results demonstrate that it is executing its turnaround plan brilliantly. Record subscribers, record revenues, and positive adjusted EBITDA are all signs that 2012 will be a great year. Over the past month or so, nothing has materially changed about the Clearwire story, except that it has become even more compelling. Clearwire was a deep value investment at $2.50 per share. At $1.80 per share it presents an even more compelling opportunity.

Disclosure: I am long CLWR, S, UPS, FDX, T, VZ, CAT.

Additional disclosure: We are long CAT, T, and VZ via the SPDR Dow Jones Industrial Average ETF

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