As telecom undergoes consolidation, the sector is likely to make winners and losers. One firm that many are saying will rank in the latter camp is Sprint (S). On a scale of 1 to 5 with 1 being a "buy" and 5 being a "sell", Sprint is rated closer to a "sell" with a 2.7 ratings (source: FINVIZ.com). From reportedly evading sales taxes to desperately attempting to block AT&T's (T) merger with T-Mobile, Sprint appears to be hanging by a thread. This is now critical moment to back the underdog and disregard the bears.
Sprint is currently trading below book value and is expected to cut back on losses after that year. Losses are anticipated to decline from $1.53 this year to $0.20 in 2014. And while the company lacks the brand of peers, it is only worth 7.8% of Verizon (VZ) and less than one-twentieth of AT&T. The firm actually offers the cheapest data plans for smartphone and mobile hotspot users, but the coverage is notoriously bad. Moreover, Verizon trades at 3.4x book value and AT&T trades at 2x book value. If Sprint showcases any signs of a beat, the stock may go skyward.
Sprint has $7.6B worth of cash and generated $3.8B worth of operating cash flow over the trailing twelve months. Now that the company can market iPhones, it has more opportunities for gaining additional clients.
For a safer investment, however, AT&T is worth an investment. The company actually offers a high dividend yield at 5% and is 46% less volatile than the broader market. It trades at 13.9x forward earnings and is forecasted for 9% EPS growth over the next 5 years. By contrast, only 3.1% annual earnings improvement is expected for Sprint. That means 2016 EPS of around $3.30, which, at a 16x multiple, translates to a $52.80 future stock value. Discounting backwards by 8% yields a price target of $35.93 - in-line with consensus and the current price. The main reason why someone would invest in AT&T is thus to realize a steady stream of income and limited volatility. On the other hand, telecom investors should be worry about "fiscal cliff" that, if left unresolved, will send dividend and capital gains taxes up more than 2.5x.
AT&T has also had better-than-expected performance through most of this year. Fortunately, margins have trended upwards while the growth rate has been more or less in-line with the industry average. Competition from iPhone sales by other carriers is less of a concern than what the market has made out, since the company has excellent cross-selling opportunities as the largest telecom firm. With around 4M TV subscribers under U-verse, AT&T needs to consider more upsetting opportunities to unlock revenue synergies. Despite a disappointing waste of $4B in its pursuit of acquiring T-Mobile, AT&T should still play the role of takeover artist since scale is king in telecom.
Note: Verizon's EPS over the past decade.
Verizon is also a relatively safe investment. The firm has slightly outperformed expectations over the last five quarters by an average of 1.5%; but, as can be seen in the chart above, earnings is volatile - certainly more volatile than the 0.52 beta would suggest. Analysts expect the company to realize 2013 EPS of $2.79 and then grow annually by 9.2% over the near-term, which means 2016 EPS of $3.64. At a multiple of 16x, the future value of the stock is $58.24. Discounting backwards by 8% yields a price target of $40 - slightly lower than the current price. Even still, the 4.5% dividend yield, low beta, and strong brand make Verizon an attractive investment from a defensive standpoint.
Disclaimer: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.