In the past, I have argued that Sprint (S) was flirting with bankruptcy and was better off dead than alive. For the sake of showing balance, I will now present a bullish thesis on the company. While the company may be bleeding more than a billion on the bottom-line, free cash flow trends would be stronger than many expect if operating metrics held steady. In this article, I will run you through my DCF model on Sprint and then triangulate the result with a review of the fundamentals against Verizon (VZ) and AT&T (T).
First, let's begin with an assumption about the top-line. Sprint finished FY2011 with $33.7B in revenue, which represented a 3.4% gain off of the preceding year. I model 6.3% per annum growth over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 55% of revenue versus 28.5% for SG&A and 9% for capex. Taxes are estimated at 30% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash flow. I estimate this figure hovering around -1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 12% yields a fair value figure of $7.60 for 215.4% upside. Perhaps most revealingly, the company will have generated enough free cash flow in FY2013 and FY2014 to break even with market capitalization. Indeed, in FY2010 and FY2009, the company generated $2.4B and $2.7B in free cash flow, respectively.
All of this falls within the context of the company trying to survive under a brutal competitive environment:
2012 marks the second phase in our company's turnaround effort, investment for future growth while we maintain our focus on our operations and execution of the Network Vision program…
I can also report another record quarter for ARPU rate growth for the Sprint platform postpaid business. Year-over-year, Sprint platform postpaid ARPU grew $4.03, the highest increase on record for any major U.S. wireless company. Today we're announcing our sixth consecutive quarter of over 1 million total net customer additions and our eighth consecutive quarter of positive net additions on our Sprint platform postpaid business. Our 56 million total customers establishes a new all-time Sprint record.
And finally, we made continued progress on the Network Vision deployment. We announced and we're on plan to launch 6 major LTE markets by mid-year.
From a multiples and fundamental perspective, however, Verizon and AT&T have better risk/reward. AT&T trades at a respective 47.8x and 12.9x past and forward earnings versus 43.6x and 14.5x for Verizon. According to NASDAQ, Sprint is the least preferred stock by analysts.
Consensus estimates for AT&T's EPS forecast that it will grow by 8.6% to $2.39 in 2012 and then by 7.5% and 7.8% in the following two years. Assuming a multiple of 17x and a conservative 2013 EPS of $2.54, the stock would hit $43.18 for 30.8% upside. What I like about AT&T is that management is attempting to solidify a monopoly position through takeover activity. 7.6% per annum growth over the next half decade is solidly within their reach especially if the company can acquire attractive interests in emerging markets.
Consensus estimates for Verizon's EPS forecast that it will grow by 15.8% to $2.49 in 2012 and then by 11.6% and 11.2% in the following two years. Assuming a multiple of 17x and a conservative 2013 EPS of $2.76, the stock would hit $46.92 for 15.8% upside. With 23 of the last 27 revisions to EPS estimates being made upwards, momentum is also in Verizon's favor. The company finished 2011 with a bang with stock appreciation outpacing peers and broader indices. Management's dividend hike further showcases confidence over free cash flow sustainability.
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