Sprint Nextel (S) is a communications provider offering wireless and wireline communication solutions with a focus in the United States. Sprint competes with AT&T (T), Verizon (VZ) and Vodafone (VOD). The company has a market capitalization of $10 billion and revenues of $34 billion.
With wireless being the future in the communication industry, Sprint is ideally positioned to profit from this trend as its main EBIT and income contributor is the wireless segment. Another strong underlying driver of growth is Sprint's strong position in the smart phone market with over 3 million sold iPhones in the first half of 2012 alone. Since iPhone sales are forecasted to increase, Sprint is ideally positioned to capitalize on this trend in the smart phone market.
Strong business and growth drivers, however, are not enough to convince the investor community: With a P/B of 0.94 the company trades less than the book value of equity and significantly discounting its immaterial assets such as patents and know-how. Investors make three mistakes when valuing Sprint:
- They discount Sprint's ability to build a competitive 4G LTE network over the long haul
- They are extrapolating high costs and lower margins, which management is addressing with various initiatives such as entering into new cooperations and divesting Nextel
- Temporary losses are overly influencing investor decision making.
Markets generally remain skeptical about intended change until they are proven wrong. Right now, investors react overly pessimistic toward Sprint's ambitious re-organization plans.
Spring quotes at $3.33 a share with $2.53 in cash alone. The company also has about $3.53 in equity per share - both metrics should comfort investors. In addition, Sprint has a P/C ratio of 1.32, which means investors assign every $1 of cash flow only $1.32 of market value. This is a striking misvaluation.
I estimate a 2014 EPS of $0.50 based on progress regarding cost optimization, stronger sales in the smart phone segment and historical revenue growth. I have also assumed a WACC of 12% reflecting the higher risk due to past EPS revisions. Applying a multiple of 12, the intrinsic value of Sprint should stand at $6 per share - based on 2014 earnings. This means the company could have an upside potential of about 100% over the next 2-3 years.
From a technical standpoint, Sprint approaches its upper bound of the trend canal at $3.50: If Sprint can surpass this level, even higher prices may be possible.
Investors who believe in Sprint managements' ability to establish a competitive network to increase margins and deploy free cash flow efficiently to the smart phone segment, should hold the stock long-term to give the thesis time to play out.
Disclosure: I am long T.