Sprint Improving, But Not There Yet

| About: Sprint Corporation (S)

As one who has followed Sprint (NYSE:S) for several years, I've been very critical of the company for its high debt load and struggle to reach profitability. Every month or two, I update investors on the company and where I see the stock going. Last week, we got a few interesting pieces of news, so I figured it was time for an update. Last week's news was fairly positive for the name. This company is definitely improving, but isn't quite there yet. I'm still recommending a short position on the name until at least the fall of this year.

The first announcement was that Sprint had reached an agreement for a credit facility for equipment financing. The company has received a $1 billion credit facility, which will allow it to purchase equipment from Ericsson (NASDAQ:ERIC) for Network Vision. The credit facility expires in March 2017 and will have a cost of funding of approximately 6 percent.

The second announcement was that the company plans to retire $1 billion of debt due in the fourth quarter of 2013. This debt will be redeemed at par, plus accrued interest up to the redemption date of June 8th. These securities were part of the Nextel Communications 2013 notes that carried an interest rate of 6.875 percent. After this $1 billion is retired, the company will still have $473 million outstanding on this specific issue.

The third major piece of news was that the company plans to cease service on its iDEN network as early as June 30, 2013. The company plans to move customers from its 2G Nextel National Network onto Sprint Direct Connect, which operates on Sprint's 3G CDMA Network. This is part of the ongoing Network Vision plan, a series of network updates to offer better service and technology to customers.

So what's my main reaction to these pieces of news? Well, Sprint is moving in the right direction. I know bulls will jump on the debt retire news, but they are entering the credit facility as well. Both carry the same total value ($1 billion), so it mostly will be a wash. There will be a slightly positive impact, because the credit facility carries a lower interest rate. However, 0.875 percent on $1 billion turns out to only $8.75 million saved, and that's pre-tax, and per year. At most, Sprint will save about $2 million a quarter (if it uses the entire credit facility). With 3 billion shares outstanding, that turns out to be a fraction of a penny per share. Now, until Sprint starts using that credit facility, the savings on interest costs will be about $15 million per quarter. That's only half a penny a quarter, or two cents a year. Given that Sprint is expected to lose about $1.53 this year currently, two cents a year isn't much, and that's only until it starts using the newly entered credit facility.

Now, the network upgrade is important, but we are still a year away from it happening, at the earliest. Sprint is trying to improve its national network, to better compete with Verizon (NYSE:VZ) and AT&T (NYSE:T). However, as I mentioned in early March, Barron's pointed out that Sprint is way behind in this race, as stated by the following.

LTE already has deepened the disparity among U.S. carriers. Verizon and AT&T are far ahead of others. Verizon has the ability to serve 200 million U.S. citizens in various markets across the country with LTE, versus 75 million for AT&T. Sprint-Nextel is just getting started. LTE "should help Verizon continue to capture the lion's share of new smartphone subscribers, and potentially a much higher share of tablet subscribers," says Davenport & Co.'s Drake Johnstone.

Although Sprint has the best pricing plans in the industry, which has helped it gain a fair share of new Apple (NASDAQ:AAPL) iPhone customers, it is still behind in its network capabilities. Sprint only offers the iPhone at the moment, while Verizon is able to capture a large share of the tablet market. Apple's iPad is selling extremely well, with expectations for 15 to 18 million iPads sold this quarter alone. Sprint has sold 3.3 million iPhones in the first six months. However, the commitment to Apple could be as high as 30 million iPhones over four years, or even more. Given that we expect a lull in U.S. iPhone sales this quarter, and perhaps next, in anticipation of the iPhone 5, Sprint could fall even further behind in its sales commitment. Could it catch up with the new phone, and what are the consequences if it doesn't meet its commitment to Apple? Sure, catching up is possible, but also remember that the more iPhones it sells, the worse off gross margins are. Gross margins in Sprint's Q1 fell more than 5 full percentage points over the prior-year period.

So why do I still call Sprint a short opportunity for the next few months? Well, it all comes down to profitability. When I first wrote about Sprint back in September, estimates called for just a $0.68 loss this year, or about $2 billion. Currently, estimates call for a loss of $1.53, or about $4.6 billion. In the past 17 quarters, Sprint has lost $12.5 billion dollars. Now to be fair, Sprint has beaten analyst estimates for the past three quarters, but that is only due to estimates being extremely low. For now, I'll give Sprint the benefit of the doubt, and say that they'll only lose $1.25 this year, which is probably the best-case scenario. That would still be a $3.75 billion dollar loss. Sprint will probably lose another $2 to $3 billion or more next year. Yes, the plan to upgrade the network is costly, and once it gets rid of the old Nextel network, it will see cost savings. But it isn't there yet. Until it is, profitability is questionable.

Estimates for the current quarter are for a loss of $0.39, or roughly $1.2 billion. Despite the company beating estimates handily in Q1, estimates for Q2 dropped two pennies since they reported. Part of the issue has to do with Clearwire (CLWR), which investors need to realize is becoming an extremely large issue for Sprint right now. Sprint has poured billions into Clearwire in recent years, and the losses continue to pile up. Since the end of Q1, Clearwire shares have fallen from $2.28 to about $1.20, and were recently as low as $1.00. Sprint has a few billion invested in Clearwire, through both debt and equity investments. The equity losses Sprint will take from Clearwire in Q2 are going to be large if shares remain barely above $1. In fact, Sprint could lose billions if Clearwire goes under, and that's not the worst part. Sprint relies on Clearwire for spectrum and other network capabilities. A Clearwire bankruptcy could hurt Sprint's network going forward. That is, the network that remains well behind Verizon and AT&T.

Sprint closed Monday at $2.54, which is basically in the middle of the six-month range, from roughly $2.10 to $3.00. The recent trade that has been working has been to buy at or below $2.25, and short at or above $2.75. I think that stays true for at least the short term. While Sprint is currently improving, it still is a year or so away in my opinion from being where it needs to be. Since markets like to be forward looking, I think that means the stock is between six and nine months away from bottoming, at the earliest. I've always said that I wouldn't seriously buy Sprint (other than for a quick trade) until it reached $1.75, and I still believe that. Until the company can improve its profitability, and until the Clearwire situation is resolved, I think there is still plenty of room to the downside. Verizon and AT&T are near 52-week highs, and Apple is one of the most popular investments around. If you are looking to benefit from the iPhone or iPad, stick with one of those three. Don't waste your time in Sprint.

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