Sprint Nextel: Profitable Enough To Warrant Investment?

| About: Sprint Corporation (S)

Sprint (NYSE:S) is the third largest wireless communications company in America in terms of wireless subscribers. It is also one of the largest providers of long distance services and largest carrier of internet connection in the country. Its corporate brand includes Sprint, Nextel, Virgin Mobile and Boost Mobile. Sprint saw a boost in growth at the end of 2011, but what does this say about the company's outlook for 2012? Should investors be looking at Sprint as an investment opportunity this year?

Sprint saw a record level subscriber additions since 2005. The company reported that it served more than 55 million customers at the end of 2011. This is a growth of 10.24% compared to the same period last year. The growth is attributed to the prepaid segment, which grew 20% year on year and wholesale and affiliate segment at 59% growth. This is also the first time in 5 years that postpaid segment did not see any substantial losses. The reason is that there are new customers due to the recent iPhone launch. Moving forward, we expect total subscribers to increase from the strong sales of iPhone alone.

Revenue is growing, but why are earnings before interest and taxes (ebitda) down? Sprint reported that revenue increased 3% in 2011. This is the first time that the company recorded revenue growth since 2006. The revenue growth was due to strong performance in wireless service and equipment, despite a decline in traditional line.

Despite a turnaround in the top line, the company reported that operating income is down by 10% from higher equipment subsidy and incremental expenses associated with iPhone sales. Also the company incurred higher wireless cost of service and network vision cost. Thus, operating margins also declined to 16.5% in 2011. After the iPhone launch, operating margins furthered declined to 10.8% on higher costs. The company expects further improvement in the revenue growth but operating margins to be around 10%. This will ultimately have an impact on the company's bottom line, unless it showed tremendous top line growth.

Earnings per share increased but it's still in the red. For 2011, Sprint reported net loss of $2.89 billion. This translates to a loss per share of $0.96, an increase of 17% compared to the previous year. However, my concern is that it would take a while before the company can earn profit, considering that it is in an investment phase. Although this is a good sign of progress, higher expenses from the roll-out of new products and investments will keep the company in negative territory.

I believe that further capital spending will reduce free cash flow. Its aggressive stance in marketing and substantial spending on its network infrastructure will reduce its free cash flow. During the year, free cash flow was lower by 48%. This was due to substantial reduction on its earnings before interest and taxes, which declined by 10%. For this year, the company plans to spend $6 billion. In addition to a higher capital spending, slower operating income will also result in lower free cash flow for the company. Investors should expect that the company will not pay dividends for the next 2 to 3 years.

I now compare Sprint to the following telecommunications companies in the market:

  • AT&T Inc. (NYSE:T) is a telecommunications provider in the United States and worldwide. It offers wireless communications, local exchange services, long-distance services and data services like data and broadband, video services and managed network. It has sales of $126 billion in 2011 and earnings before interest and tax of $30.50 billion, or equivalent to 24.07%. Its net profit is at $3.94 billion. Analysts expect AT&T to earn $2.36 per share this year, implying a price earnings ratio of 12.36 times. It also has a dividend yield of 5.90%.
  • Verizon Communications (NYSE:VZ) is a provider of communications services. It operates under two divisions: domestic wireless and wireline. Its domestic wireless products include wireless and voice and data services. Meanwhile, its wireline services include voice Internet access, broadband video and data and Internet Protocol network services. Its main operations are in the United States but it has presence in over 150 countries around the world. It has sales of $110.8 billion and earnings before interest and taxes of $29.38 billion, or a margin of 26.50% in 2011. Its net profit is at $2.40 billion. Analysts expect the company to earn $2.49 per share. This implies an earnings multiple of 15.46 times. It also has a dividend yield of 5.2%.
  • USA Mobility Inc. (USMO) is a wireless communications provider to the healthcare, government, enterprise and emergency response sector. It operates networks for both one-way paging and two-way messaging services. It also offers mobile voice and data services. It has revenues of $233 million and earnings before interest and taxes of $80.16 million. Net profit is at $33.40 million. It trades cheaply at 3.02 times trailing earnings and has dividend yield of 6.80%.

Based on the data above, it seems that Sprint has only 1/3 of the telecommunications giant revenues. In terms of scale, both telecommunications giants have a significant advantage over Sprint. In fact, Sprint has sales of $33 billion and earnings before interest and tax of $4.97 billion. Analysts expect that the company will still incur loss per share for this year. Thus, we do not have direct comparison in terms of valuation. The company does not declare dividends.

It's good to see that Sprint has significantly improved its top line figures. The main challenge is to post profits to be able to convince investors of the attractiveness of its shares. I would recommend investors to put Sprint in their watch list as a potential turnaround play. Buying the shares of Sprint at this point appears speculative.

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

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