Imagine If Sprint Hadn't Beat Estimates

| About: Sprint Corporation (S)

It's been quite a ride for Sprint (NYSE:S) shareholders since Wednesday. Earnings were out and the company beat estimates on the top-line (growing wireless revenues by an impressive 7%, in the process; 16% for the Sprint platform), they beat estimates on earnings, and they revised their OIBDA (operating income before depreciation and amortization) guidance to the top of the previously guided range.

Furthermore, the company confirmed substantial and timely progress on their "network vision" and 4G LTE programs, reported solid sales trends for Apple's (NASDAQ:AAPL) iPhone (holding up from the strong fourth quarter much better than AT&T (NYSE:T) and Verizon (NYSE:VZ), and reported a substantial liquidity cushion of over $7bn in cash (after the completion of another $2bn in financing initiatives during the quarter).

On the back of all of these positive developments, Sprint shares are about flat (after a volatile 4 days of trading). And so it goes for Sprint… a company which truly can't seem to do anything right in the market's eyes. With revenue and earnings beats and improved guidance updates, it appears that the main concern with the recent results was with respect to subscriber additions, so let's look at those numbers in detail to better understand the source of concern.

To begin with, the Sprint platform's pre-paid and wholesale subscriber numbers remained extremely strong (up 38% and 63%, year-over-year, respectively). While those are very impressive growth numbers, the market appears to focus much less on these rapidly growing parts of the business (and the closing Nextel side of the business) and focus more on the Sprint platform's post-paid subscribers (the high value subscribers: high-ARPU and low churn), which appeared to disappoint the market.

With respect to the Sprint platform's post-paid platform, the company actually did add more subscribers in Q1 2012 compared to the prior-year period (263k versus 253k; up 4%), albeit additions were down sequentially (again, as the fourth quarter is seasonally strong and benefitted from the iPhone's 4S launch). It appears, however, that the absolute amount of net additions and the rate of increase was of some concern to the market -- presumably, given the fact that Sprint recently gained access to the popular iPhone (offered this quarter and not in the prior year period) and also considering the fact that 209k of the net 263k adds (79.5%) could be attributed to Nextel churn recapture (while only 99k post-paid subs were recaptured in Q1 2011). In other words, the Sprint platform's post-paid net additions were only 263k (up 4%), despite gaining access to (and committing substantial capital towards) the popular iPhone and despite benefitting from the significant recapture of customers coming off of the Nextel side of the business. Understandably, this could make the subscriber trends seem somewhat questionable, in isolation.

When digging deeper into the numbers; however, a different story is told. When we look at churn (% of the existing customers lost) for the respective periods and the resultant breakdown of gross additions (new subscribers added) and net additions (new subscribers added less existing customers lost), we can see that the Sprint platform increased gross additions (i.e. new customers) substantially (by 10% over the prior-year period.) These gross additions, however, didn't result in more substantial net additions (albeit, they were up a respectable 4%) because churn went up from 1.78% to 2.00%, year-over-year. This would be of concern, if it was a long-term trend and/or was expected to continue; however, management clearly explained that the increased churn was due to a temporary period of high involuntary churn (customers forced to leave for non-payment, etc.) because of some indirect channel deals that were made in 2011, as explained in the recent quarterly report:

"Sprint platform postpaid churn increased year-over-year primarily due to higher involuntary deactivations, which occur when Sprint disconnects a customer due to lack of payment or violations of terms and conditions. This is expected to be a temporary increase, the majority of which was associated with pricing actions taken in the second and third quarters of 2011 primarily through indirect channels. Sprint tightened its credit standards during the third and fourth quarters of 2011 to stem further impacts of these types of promotional activities by our indirect dealers."

Going forward, the Sprint platform's post-paid churn is expected to steadily improve as a result of this issue working its way through the system, amongst other factors. Beginning in the second quarter, the company expects a reduction in the Sprint platform's post-paid involuntary churn, with longer-term improvements in voluntary churn resulting from ongoing customer experience improvements, the iPhone, and the fact that Sprint's postpaid base on contract is at a 4 year high, in percentage terms. The expected churn improvements should then allow for net additions that are substantially higher, vis-à-vis the company's reported gross additions.

With respect to the success of Sprint's iPhone sales, the company was able to maintain sales levels (after the seasonally strong/product launch quarter Q4) much better than AT&T and Verizon and substantially increase their share of sales between the three operators (as seen in the chart, below). For the recent quarter, Sprint's iPhone sales declined by 17% sequentially (versus 43% and 26% declines, respectively for AT&T and Verizon). Furthermore, Sprint's share of iPhone sales, between the three carriers, increased by an impressive 27% (up from 13% to 17%). AT&T's and Verizon's larger subscriber bases give them an inherent advantage with respect to absolute iPhone sales numbers (as they have a much larger base of captive existing customers who can upgrade to the iPhone), but the current trends clearly appear to favor Sprint.

  Q4 2011 Share Q1 2012 Share
AT&T: 7.6 55.5% 4.3 47.8%
sequential change:     43.4%  
Verizon: 4.3 31.4% 3.2 35.6%
sequential change:     25.6%  
Sprint: 1.8 13.1% 1.5 16.7%
sequential change:   16.7%  
Total: 13.7 100.0% 9.0 100.0%
Click to enlarge

In summary, subscriber growth remained strong for Sprint and customer growth trends (particularly without the one-off factor that temporarily influenced churn), were very positive and a further reason for optimism. I believe that these subscriber trends, along with the other positives reported for the quarter (a revenue and earnings beat, confirmed higher OIBDA guidance, substantial operational progress, etc.) should have provided a positive catalyst for the stock. As we have seen, however, Sprint recently can't seem to win, no matter what they do, and the share price has remained essentially flat (after much volatility). It seems that Sprint is the kind of company that could report massive earnings improvements -- taking them from a loss to billions in profits -- and the market takeaway would be a negative view that income taxes were going to increase.

All that said, sentiment can change quickly and capitulate sharply and if Sprint continues to deliver good results, I believe that the share price will eventually reflect the positive developments and I do believe that Sprint's shares offers a very attractive risk/reward opportunity at current levels. In the meantime, be warned that it's sure to be a volatile ride, and the bottom may yet to have been reached -- although I don't believe that's a good reason to miss this attractive risk/reward opportunity (by trying to time the bottom). With that in mind, I quote Bernard Baruch who said: "Don't try to buy at the bottom and sell at the top. It can't be done except by liars."

Disclosure: I am long S, AAPL.