Sprint Nextel's Internal Explosion

The value of Sprint Nextel (S) stock will continue to deteriorate further in 2008. Sprint is in a very defensive position – currently with a debt to asset ratio of 66% mostly associated with the $29.7 billion goodwill that was impaired from the Nextel acquisition. Customer defections will nearly double again in the first quarter to 1.2 million. While Sprint lost 700K customers in Q4 2007, Verizon (VZ) added 2 million. Additional charges for employee reductions and store closings indicate a loss for Q1. Revenues will decrease more significantly in Q1 than from Q4 due to the charges, loss of customers, and service price reductions.

Sprint has lost over 70% of its market value in 8 months ($46 billion). Current market cap is $20 billion. This author argues that Sprint can only be valued at this amount based on 2 scenarios – 1) future earnings, or 2) value of assets.

Using the $20 billion market capitalization, and assigning a forward p/e of 20 for 2008, indicates that the company has to generate net income of $1 billion for the year – which will be impossible in relation to current trends. Revenues declined 2% for third quarter to fourth in 2007, and Q4 should a decline of 6% in revenues for Q4 2006. Using the company’s statement concerning customer defections being 1.2 million in Q1 of 2008, a further sequential quarterly decrease of at least 4 % can be expected.

Additionally, the company immediately announced a reduction is service price, which one could consider a desperate measure. If the prevailing issue is loss of revenue – how does cutting the price to current subscribers increase revenue? It does not. This is an attempt to slow the rate of customer defections, or lessen the rate of decrease in revenue. To offset operating expenses against the loss of revenues, the company has reduced workforce and closed retail locations. This is a short term solution to the long term problem. Service level will be negatively affected.

Removing the $29.7 expense for goodwill impairment, Sprint has a net loss from continuing operations before income taxes for 2007. Considering all factors, this author for expects Sprint will not generate positive net income in 2008.

Wireless market

A business asset’s true value is the ability to generate income. The impairment was recognized because the asset, goodwill, was unable to be utilized to generate income. This author has read many statements in the last few weeks arguing that the book value of Sprint – currently $22 billion – justifies the current valuation. Simply stated, if Sprint is unable to produce a return on these assets going forward, they are overvalued.

Speculation runs rampant about potential acquirers of Sprint. First, anyone considering something that is broken would require a discount. Sprint is significantly “broken” – therefore a significant discount would be required. Second, one must look at the Verizon and AT & T (T) – the dominant entities in the US market.

The wireless market is maturing from the growth stage of the last decade. Both Verizon and AT&T have the luxury of viewing this downfall of Sprint as the avenue to increase profitability – because Sprint is giving them the market share. Customers will continue to matriculate to VZ and T at an increasing rate. Both have no impetus to “overpay” for Sprint’s assets and customer base. Possibly the most significant comparative financial ratio at this point is – operating margins. VZ and T have operating margins of 5 times of the operating margin of Sprint.

Hindsight clarifies issues

Future analysis will provide the details of poor decisions by Sprint management and directors over the last few years. Customer service issues were resultant of top down policies to extend customer contracts over every concern of customer satisfaction. Future college business policy textbooks will contain case studies of Sprint’s downfall being precipitated from internal mismanagement rather than external market factors.

Disclosure: Author has a short position in S

Comments

[your dad:]

Thats your que xnext.

2008 Mar 02 08:53 AM

[Dave Davidson:]

I would be cautious shorting shares of Sprint at these levels. The company is down more than 70% from it's 52 week high and has declined over 25% in the last week. While the company's financial performance more than justifies these reductions, significant future reductions are unlikely for the following reasons:

-The enterprise value of Sprint has fallen to just over $40B; $20B from debt (including the recent $2.5B loan) and $20B in market capitalization. At these levels, each Sprint subscriber is valued at just $950.00, nearly half the amount that Cingular paid for AT&T Wireless in 2004.
-CEO Dan Hesse "kitchen sinked" the 2008 earnings forecast and set expectations to near ZERO expectations. If they are predicting a loss of 1.2M subs in Q1 and Q2, I would expect something less. He has replaced the old leadership team and instituted a "back to basics" play book which overtime will significantly improve customer satisfaction and retention.
-The company borrowed $2.5B to pay off maturing debt and provide liquidity beyond the $2.2B in cash they currently have on hand. Since this transaction will be used to pay maturing debt, it will not increase the amount of debt outstanding. In addition, the company eliminated their dividend which will save approximately $300M annually, further improving the company's liquidity.
-The value of the company's spectrum alone is worth well in excess of $20B. Just look at the bids from the companies involved in the latest government auction for proof.
-An announcement regarding the future of WiMax and possible investments from Intel are rumored to be coming the following weeks.
-Much of the incremental selloff of Friday was due to the overall market being down over 360 points at one point. Shares of Sprint actually held up well on Thursday and only moved down of Friday after the credit rating downgrades.

Overall, the business outlook for Sprint for the next 3 quarters does not look good, however most of the bad news is baked into the shares. The stock could see an incremental 5-10% downside if the overall market sells off this week, but I would be cautious in opening short positions at these levels. If you do, I would stay close to my computer to ensure I would be able to quickly cover my position should any positive reports about Sprint come out. Right now all the sentiment is bearish...that's normally when you get a reversal.
Finally, I doubt the company will be acquired in the short term, but the prospect of that happening will keep the shares from totally tanking.

Good luck to all investors. This is a tough market!

2008 Mar 02 10:56 AM

[User 159223:]

I agree. In trying to value Sprint one needs to consider the enormous "real estate" they are sitting on in the 100MHZ of spectrum. Sure Sprint has a huge disadvantage right now in the Cell phone business to VZ and T, but on they other hand the internet is going wireless as well and Sprint is sitting in perfect position to scoop up 100-180m Wimax Subscribers in the next two years with XHOM. I see Sprint being able to scoop up millions of Wimax subscribers, who will also as a result be voice subscribers as well in the next 2 years.

2008 Mar 02 12:45 PM

[mguimei:]

I am not surprised with their huge loss of customers. They have the worst customer service and their billing is always wrong with monthly over charges.

2008 Mar 02 01:15 PM

[lntwo:]

The last paragraph nails it. A service industry that viewed itself as a sales industry. One might argue that these are inseparable, but Sprint chose a more sales driven model that alienated many customers.
I work in Sprint customer care and let me tell ya the cust. svc. integration with Nextel is far from over. We're using a new cust svc. software that is far from user friendly, and as the the third party provider that runs Sprint's cust. svc. continues to bottom line the service agent wages, there will continue to be employee churn, in turn driving service issues and cust. dissatisfaction. Observing the slow motion car wreck has been fascinating.

2008 Mar 02 03:01 PM

[your dad:]

intwo, You're fired.

2008 Mar 02 07:24 PM

[Dan Jacome:]

Goodwill isn't an asset - it's a plug used by accountants when they can't identify what an acquirer is really paying for....

2008 Mar 02 08:23 PM

[Ade:]

I think there is a lot more to be done to make Sprint Nextel one company. I will not discount the ability of the new leadership team at Sprint to turn things around. I think with the upcoming WiMax, Sprint might be able to add more paying subscribers. I will be very cautious with my position at this time.....long term I think S will pay off, the question is when?

2008 Mar 02 11:29 PM

[martyg:]

sprint has the worst service and is the poorest run wireless company. anybody defending their spectrum as a great asset is dreaming. lifting sprint's baggage would even give verizon a hernia. the bottom line is that sprint will disappear and the bones will be distributed to the other dogs.

2008 Mar 03 12:58 AM

[your dad:]

Sprint is not going away. VZ likes to act like its a non issue but the reality is much different. Its going to take time but the policies verizon puts in place are not advantageous to the consumer.

2008 Mar 03 01:09 AM

[your dad:]

intwo: I see you are a contractor not an employee. Why would you lie to us?

2008 Mar 03 01:15 AM

[lntwo:]

0.02: No lie just observation/opinion. As far as shorting the stock at this point hmmm... seems to be more momentum investing (2-3 years late) than analysis. WiMax/backhaul tech. from what I've read appears to be the wireless data game changer but rather than invest in S why not the backhaul tech, companies that supply the tech. Pseudo is 'L' n as in natural log. Out.

2008 Mar 04 11:07 AM

[Soup:]

I agree with the author, how is cutting your prices going to improve margins and customer service? My man on the street marketing tells me people aren't upset about the cost of wireless they are upset about the lousy customer service they receive from any of the carriers. However, since wireless management isn't that smart they tend to drop their prices everytime a slow down in sales happens instead of really trying to figure out the problem.

Sprint should adopt a rewards program whereby customers earn dollars towards their next phone upgrade with every dollar spent on the network. I think they need a service that is so good, you don't need a contract. The Voce model failed but they had a good idea and just poorly executed. If you were the Nordstroms of wireless carriers people would pay a little more to get that kind of customer service and quality. Read the comments of the VOCE customers. They LOVED the service and they were over paying for the service.

2008 Mar 05 10:57 AM

[A Bomb:]

The best bet is to unload some of the assets such as the IDEN Network, Long Distance and possibly WiMax. The company is a trainwreck and its only going to get worse. There may be one HQ now but the mentality has changed which Sprint would rather be 3rd then do anything innovative. The company is reactive and not proactive in anything that is offered to their customers...

2008 Mar 05 03:27 PM

[Mav:]

Your article speaks to your ignorance of the industry. Get a clue, and try not rehashing old news.

2008 Mar 14 09:43 PM

[Hinutech:]

I have been continually disappointed with Nextel since the merger. It has been a horrific customer service experience, and as a long time subscriber, I took great joy in leaving them today (hinutech.blogspot.com/...)

This merger has been nothing short of disastrous. They have not succeeded in effectively merging the companies. The branding has suffered. The service levels have suffered. Their declining subscriber base is all the proof that is needed as proof.

2008 Apr 15 09:25 PM