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We believe that Sprint Nextel (NYSE:S) is a buy at current valuations based on the following reasons:

  • With strong demand for iPhones, Sprint will likely see an acceleration in the number of subscribers, while reducing churn.
  • Virgin Mobile, owned by Sprint, has become the second largest U.S. prepaid service to offer Apple (NASDAQ:AAPL) devices. High demand for Apple's products in the prepaid market could boost the company's margins going forward.
  • Sprint is gaining strong traction with its HTC EVO, LG, and Samsung products.
  • Sprint is expected to launch its 4G LTE in six major cities by midyear 2012. Moreover, with other carriers phasing out unlimited data, Sprint is the only company that is offering unlimited data.
  • The company has enough financial strength with its cash of $8 billion and free cash flows of around $2 billion.
  • Based on 2014 expected earnings, and a multiple of 15 times, the stock can trade north of $4.50.

Sprint offers a range of wireless and wireline communications products and services to individual consumers, businesses, government subscribers, and resellers in the United States, Puerto Rico, and the United States Virgin Islands. It operates in two segments, namely wireless and wireline, with the majority of its revenues coming from the wireless segment. Sprint is the third largest wireless communications company in the United States, based on wireless revenues.

Disappointing Quarterly Results

The company announced its quarterly results in April 2012, reporting a net loss of $863 million and a diluted net loss of $0.29 per share. This compares to a net loss of $439 million and a diluted net loss of $0.15 per share in Q1 2011. The company provided a positive earnings surprise of 30% in the first quarter results. Revenues of $8.7 billion for the quarter were 5% higher than in the first quarter of 2011, and nearly unchanged from the fourth quarter of 2011. The quarterly year-over-year improvement was primarily due to higher wireless service revenues. However, the higher wireless service revenues were offset by lower wireless equipment and wireline revenues. The first quarter's operating loss was $255 million, compared to an operating loss of $438 million for Q4 2011. Factors like wireless cost of service and lower wireline revenues led to the losses.

Overall, the financials have been mixed for the company. However, let us look at some of the factors that have led to the recent share price strength.

ARPU Increase

The company had wireless service revenues of $7.2 billion during the quarter, an increase of more than 7% year over year, driven primarily by Sprint platform postpaid ARPU growth of $4.03. That is also the largest year-over-year increase on record for the U.S. wireless Industry.

Click to enlarge images.

Wireless cost of service was flat sequentially, primarily due to lower 4G data costs. Wireless cost of service increased approximately 12% year over year, primarily due to higher 4G data costs.

Eighth Consecutive Quarter of Postpaid Subscriber Growth

The company served more than 56 million customers at the end of Q1 2012. This includes 32.8 million postpaid subscribers, 15.3 million prepaid subscribers, and around 8 million wholesale and affiliate subscribers. The total number of customers on the Sprint platform grew almost 4% sequentially, including 263,000 postpaid net subscriber additions, 870,000 prepaid net subscriber additions, and 785,000 wholesale and affiliate net subscriber additions.

Churn Rate

For Q1 2012, the company showed slight deterioration in the Sprint platform postpaid churn rate, rising to 2% from the previous quarter's 1.99%. This rise in the churn was largely due to higher involuntary deactivations, which occur when the company disconnects a customer due to lack of payments. However, this increase is likely to be temporary as it was mostly associated with pricing actions taken by the company. Compared to the postpaid churn, the prepaid churn for Q1 2012 was 2.92%, an improvement from the year-ago churn of 3.07%. This improvement was driven by improvements in the Virgin Mobile and Boost brands.

Sprint and iPhone

The company sold over 1.5 million iPhones in the first quarter, with 44% going to new customers. Also, Sprint is expected to launch 4G LTE in six major cities by midyear 2012, including Houston, Dallas, San Antonio, Atlanta, Kansas City, and Baltimore. Sprint has already launched its 4G LTE smartphones, Galaxy Nexus™ and LG Viper™ 4G LTE. Moreover, with other carriers phasing out unlimited data, Sprint is the only company that is offering unlimited data.

Bullish Scenario

The company is gaining strong traction with its HTC EVO, LG, and Samsung products. These smartphones would fuel Sprint's earnings and margins going forward. Moreover, with a strong demand for iPhones, the company could see an acceleration in subscriber numbers, while reducing churn. With good demand for Apple's products in the prepaid market, Virgin Mobile could see a boost in its margins going forward.

Bearish Scenario

Given intense competition in wireless, Sprint could continue to see its bottom line under pressure. The company expects a capex of around $6 billion in 2012, mainly for network upgrades and to meet its 4G needs. Moreover, the company has substantial commitments to Apple for the subsidies offered on its products, which could continue to keep its margins under pressure.

Stock Performance

The recent strong stock performance for Sprint is evident in the following graph, with the stock outperforming Verizon (NYSE:VZ) and the market benchmark:

Financial position

The company's financial position is strong with cash of around $8 billion on its balance sheet, and free cash flows of around $2 billion. Sprint has a high debt-to-equity ratio of 200%, higher than AT&T's (NYSE:T) 60%, and a total debt in excess of $20 billion as of the most recent quarter, which are well supported by its healthy cash flows. Net cash provided by the company's operating activities improved by almost 7% in Q1 2012 from the year-ago quarter.

Valuation

Based on its price-to-sales ratio, the stock is trading at a discount of 75% and 82% to the industry average and AT&T, respectively.

Recommendation

The company is expected to report positive earnings in FY 2014, and based on a forward P/E multiple of 15 times the consensus 2014 EPS estimate of $0.30, we expect the stock to trade north of $4.50 -- which is 30% upside. Because of this upside and the reasons discussed above, we recommend a long strategy for Sprint.

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

Source: Buy Sprint: A Turnaround Story