Sprint (S) has had an amazing run, as of late, for reasons that I discussed in a recent article. Since the market close on the day of Sprint's most recent earnings, through yesterday, Sprint has outperformed the S&P 500 by 31%, versus outperformance of 12% and 14% for Verizon (VZ) and AT&T (T), respectively (see below).
Closing share price
April 25th (earnings day):
Source: Yahoo Finance
The question, now, is how much upside remains for the stock? Looking at longer-term margin potential and current trends, I would argue that additional upside is considerable and the market is still substantially undervaluing Sprint. But, before we consider further upside potential for the shares, let's first review how Sprint has recently addressed many market concerns, allowing for the outperformance that we have already witnessed:
Liquidity: During 2011, Sprint's liquidity position was a concern to the market, with upcoming maturities looming and uncertainty with respect to how the company would be able to meet these obligations. To address this issue, management has substantially improved the company's liquidity profile. In fact, from the first quarter of 2011 to Q1 2012, Sprint has improved their liquidity position by about $3.0bn -- ending the most recent quarter with $8.8bn in liquidity (including $7.6bn in cash), with only around $3.0bn in maturities coming due through 2014.
iPhone offering: Another big market concern in 2011 was that Sprint didn't offer the iPhone, putting them at a significant competitive disadvantage vis-à-vis AT&T and Verizon. Since that time, Sprint has secured the iPhone in its product offering.
The initial market reaction to the news of Sprint obtaining the iPhone was negative, because of margin concerns and the risk of the company not meeting their 4-year $15.5bn dollar iPhone commitment with Apple (AAPL). These concerns seem to have subsided; however, as Sprint's post-paid iPhone sales trends appear positive and Sprint recently announced that they would also be offering a pre-paid iPhone through their Virgin Mobile subsidiary -- providing further upside sales potential.
Overall uncertainty and execution risks: With all that is going on with Sprint, a great deal of uncertainty and execution risk has weighed on the shares. Positively, these concerns have recently diminished (somewhat).
Apart from the positive news with respect to liquidity and the iPhone (as discussed, above), there have been other positive developments for the company. Management provided a guidance update with Q1 2012 results, indicating that the company expected 2012 adjusted OIBDA to be at the top end of the previously-guided range. Subsequently, the company announced that they expect to close their costly IDEN network as early as June of 2013. Both of these announcements provided further positive evidence of continued financial and operational progress.
So, where do we go from here? Simplistically, let's look out to 2014, after "network vision" (N.V.) has been completed and see where Sprint may stand from a valuation perspective, at that point -- considering that current trends continue and NV progresses as planned. To repeat and to be clear, this analysis assumes that current trends continue and NV is a success. While many concerns/hurdles have been passed for Sprint, over the past year (with respect to securing financing, progressing with NV, securing the iPhone, etc.), much execution risk remains and I am not suggesting that the valuation resulting from this analysis is where Sprint should trade today. There should clearly be a discount that factors in these execution risks. With that in mind, let's do a simple back-of-the-envelope valuation forecast.
If we assume that revenue growth continues at 5% per annum (in line with current trends) and OIBDA margins expand by 900 bps, from 2011 levels, to 24.1% (by comparison, this is still well below Verizon's 2011 adjusted EBITDA margin of 31.4%), we get to 2014 revenues of approximately $39bn and adjusted OIBDA of around $9.4bn.
Using a conservative enterprise value (E.V.)/Adj. OIBDA multiple of 5.0x, gives us an enterprise value of $47bn. Assuming an increase in net debt from $14.8bn at YE 2011 to $17.25bn at YE 2014 (my back-of-the-envelope estimate, under the scenario described), would leave Sprint with a market capitalization of $30bn, which would translate into a share price of approximately $9.91 (317% above yesterday's close).
I should add that, while there is substantial execution risk between now and then, these assumptions are not aggressive. Adjusted OIBDA margins improvements are the mid-range of management's guidance of margin improvements from NV(800bps - 1000bps) and this leaves Sprint with forecasted margins still substantially below those of Verizon or AT&T (31.4% and 32.3%, respectively in 2011), historically. Furthermore, revenue growth is consistent with current trends and the EV/Adjusted OIBDA multiple of 5.0x is conservative (as of yesterday's share price, AT&T trades at above 6.5x 2011 adjusted EBITDA).
I see upside potential from these forecasts, but downside potential clearly exists, as well. Furthermore, as I said before, the share price clearly needs to factor in a discount for the substantial execution risk that remains. All that said, I believe the overall assumptions are reasonable and they allow for a substantial negative variance, before you even get close to current valuations. Overall, I continue to believe that Sprint remains one of the most attractive opportunities, from a risk/reward standpoint, in the market today.