Leap Wireless (LEAP) has had an abysmal year in terms of stock performance, losing almost 37% of its value since the start of the year. The stock is currently trading at cheap valuations, as reflected in its P/B and P/S. However, we believe it can be a value trap, as the company continues to bleed customers, with margins consistently contracting and losses piling up.
LEAP, a telecommunications company, provides wireless services to a customer base that is centered largely on young consumers. With its business model based on pay as you go services, LEAP is well known for its Cricket Brand, through which it provides wireless services that include voice, text and data at a flat rate without contract.
Leap, with its focus on more cost-conscious customers, has been losing customers for quite a while now, something that was reflected in its latest results. Quarterly revenues, despite a slight increase from the previous quarter, were below analyst expectations, with deterioration in all major metrics for the company. Average revenues per user, despite growth from the same quarter of the previous year, declined for the first time in two years. The key problem for Leap is that with an increasing trend towards the smartphone market by all telecom carriers, the company needs to shift its focus as well in order to retain customers that are already leaving for other networks. This means it has to pay more in subsidies to smartphone manufacturers, further eroding its margins. The company has recently started to sell the iPhone, but important to note is the difference in subsidy costs incurred by carriers like Verizon (VZ) and AT&T (T), as compared to Leap. Verizon, for example is paying around $450 in subsidies for one smartphone sold, as compared to LEAP, which is offering the iPhone 4 for a price of $500. Perhaps that is the reason why it has seen a steady increase in churn in the recent quarter. Of course, if the company does decide to lower prices for its customers, it will lead to further margin erosion, and the company will end up burning cash. Another worrying aspect for LEAP is that its management is expecting an even higher churn in the third quarter, largely due to the failure of various retention programs designed to extend customer life on its network. In the second quarter, the company lost almost 290,000 subscribers compared to a loss of 100,000 customers at the end of 2Q2011.
Leap recently announced its new wireless plans in an effort to turn around its piling customer losses. The new plan offers unlimited talk and text, as well as Cricket's muve music service.
If the prices of the new plan are compared to the previous plans, one can see there is not much of a difference. Before, the cheapest plan would cost customers $55 per month, with an additional charge for its muve music service. So the new plan is not necessarily going to save money for customers, rather it gives them more options in terms of device connectivity, and that too at a higher cost. Bad news for Leap is that T-Mobile has already launched its unlimited data plan, which combined with unlimited voice and texts, will cost somewhere between $69-$89. Moreover, the company also claims that unlike Verizon and AT&T, who charge customers for exceeding their limits, T-Mobile doesn't charge overage fees. With the introduction of its recent plan, T-Mobile has also joined Sprint (S) as the only telecom operator to be offering unlimited data plans. This could especially work in favor of Sprint and T-Mobile, as other carriers are phasing out their unlimited plans.
LEAP is trading at cheap valuations indicated by its price to sales multiple of 0.15X which is at a discount to Sprint's 0.45 and Verizon's 1.1x. However, we believe in the absence of earnings growth, margin expansion and improving business metrics, these cheap valuations don't justify buying the stock.
For a detailed analysis on LEAP, click here.