The past several weeks have been some of the most dramatic ever for investors in Clearwire (CLWR). The constant back and forth of rumors and headlines surrounding the Sprint (S)-SoftBank deal and how it affects Clearwire have caused shares of Clearwire to see record volatility over the past several weeks.
Investors have eagerly anticipated Clearwire's Q3 2012 earnings, posted after the markets closed on October 25, for they would give them a chance to hear management's take on recent developments. After reviewing the company's earnings, we believe that the long-term thesis regarding Clearwire is fully intact, and we delve into this below. While we will provide an overview of the company's headline numbers, the events of the past several weeks, in our view, take precedence over the results of just one quarter, and we think that it is these larger issues, such as corporate governance and spectrum monetization, that need to be addressed. Unless otherwise noted, financial statistics and management commentary will be sourced from either Clearwire's Q3 2012 earnings release, or its Q3 conference call. Our discussion of the company's results will be broken into 3 parts: an overview of the quarter, the company's views on spectrum monetization and its financial strength, and potential changes in corporate governance.
Clearwire posted revenues of $313.882 million in Q3 2012, down 5.51% from a year ago. However, that number beat consensus estimates by $1.9 million. The company's headline EPS came in at -$0.34, missing estimates by 7 cents. However, that is down sharply from the 54 cents per share lost in Q3 2011, and the company's losses from continuing operations narrowed to 22 cents per share, down sharply from a loss of 53 cents per share a year ago.
Clearwire, on its Q3 call, raised its adjusted EBITDA guidance, with the company now calling for a loss of $150-$200 million, a $25 million improvement from prior guidance of $175-$225 million. The increase in EBITDA is driven by lowered capital expenditures for the remainder of 2012, a decision that we believe makes sense and does not damage the company's long-term ability to launch a leading LTE network. Clearwire stated on its call that it expects to have 2,000 LTE cellular sites online by June 2013, the month it is set to begin receiving LTE payments from Sprint, and the decision to defer network spending was due to a preference to align that spending with the receiving of cash from Sprint, not operational issues that prevent the company from proceeding at the speeds that it has previously forecast. Capital expenditures for all of 2012 are forecast to come in between $125 and $175 million, compared to the company's previous forecast of $350-$400 million. Investors should remember that these investments are not being eliminated, but rather deferred, and will now shop up in the company's 2013 results as opposed to its 2011 results. Clearwire already has LTE sites ready, and more than 800 are set to be online by the end of the year. Clearwire has selected Cisco (CSCO) and Ciena (CIEN) to form the core if its network. We continue to believe that Clearwire is on the right path with regards to its LTE network, and look forward to the company's Q4 results to see what kind of progress it has made on
Spectrum Monetization, Debt, and Cash: Financial Security is Improving
Much has been made of Clearwire's spectrum portfolio (the largest in the United States), and what the company can do with it to shore up its balance sheet. And this quarter's conference call featured even more speculation about this issue, given all that has transpired over the past several weeks. BTIG opened up the call, asking CFO Hope Cochran why the company has passed on refinancing its debt, even though "the debt markets are strong," as BTIG put it. If Clearwire isn't looking to refinance debt, even when there is an opportunity to do so, doesn't that imply that another source of capital is available, and on the way? CFO Hope Cochran responded, as she always does, by declining to comment on speculation, but she did add that "we [Clearwire's executive team] do stay very close to the markets and make sure that we are tracking the movements and what opportunities are there."
Questions regarding spectrum monetization did not stop there, and it is because of the equityholder's agreement struck in 2008 between Clearwire, Sprint, and the company's other strategic investors when it was reorganized in 2008 via the merger of legacy Clearwire and Sprint's broadband division. This equityholder's agreement is one of the most complex and convoluted financial documents that we have ever come across, and it covers a very wide variety of things that Clearwire can and cannot do. On the call, CFO Hope Cochran stated that the events of the past few weeks have not changed the company's ability to sell spectrum, and she once again reminded investors that the equityholder's agreement gives Clearwire a great deal of latitude in defining the meaning of "excess" spectrum. Merrill Lynch openly asked whether or not the company is engaged in the process of selling spectrum and whether or not a debt-for-spectrum swap could take place. CFO Hope Cochran dodged the question of whether or not the company is in a sale process, but did state that, "Now you specifically asked about a debt swap for spectrum. You have to look at then how the debt would handle a spectrum sales versus -- and our ability to sell spectrum. If we were to sell spectrum, we can use the proceeds to pay back debt and it would need to go to all of the debtholders equally within that class, so we would need to be careful of that. But I do think there is opportunities to work through some sort of reduction of debt with a spectrum sale." We expect that spectrum monetization will become even more prominent towards the middle of 2013, as Clearwire begins to think about its longer-term funding plans, and whether or not parting with spectrum is prudent. In our view, the company should, at a minimum, be in discussions with other wireless companies about selling off spectrum. As several of our previous articles have stated, even CFO Hope Cochran herself has said that the company has more spectrum than it needs, and a reduction of debt via the sale of that spectrum would go a long way towards increasing investor confidence in Clearwire.
The equityholder's agreement requires that 10 out of Clearwire's 13 directors approve any sale larger than 20% of total assets. Based on the company's $8.149658 billion in assets, that would allow Clearwire to sell just over $1.6 billion in spectrum with the approval of just a majority of the board. However, with Clearwire's board mostly independent (an issue we will discuss in the next section of this article), getting 10 out of 13 votes should not be an issue if and when Clearwire decides to sell more than $1.6 billion of spectrum.
Turning to cash and cash flows, Clearwire ended the quarter with $1.183668 billion in cash & investments, and the company said that it has sufficient funding for the next 12 months. On the call, CFO Hope Cochran also reiterated that, "as we consider our longer-term liquidity needs, we expect to receive LTE prepayments from Sprint in the future and continue to evaluate all potential sources, including strategic transactions, asset sales and capital market opportunities to meet our needs. Just as it stated on its Q2 call, Clearwire is open to a "strategic solution," and we believe that discussions regarding this will become more robust towards the second half of 2013 as those longer-term liquidity plans become a prime focus for Clearwire. Sprint reported its earnings before the markets opened on October 25, and naturally, the issue of Clearwire and its funding were brought up on that call as well. CEO Dan Hesse deflected essentially everything regarding Clearwire, telling analysts that, "Clearwire-specific questions you'll have to address to Clearwire." However, Hesse did reveal a slim piece of information in response to a question from Merrill Lynch, which was just as aggressive with its questions on Sprint's earnings call as it was on Clearwire's. Merrill Lynch analyst David Barden asked Dan Hesse, "I apologize, Dan, if I could just follow up on your answer to the Clearwire situation. Obviously, Clearwire has a situation where it has a finite amount of funds. It has a important strategic role to serve as a partner for Sprint. How do you square the circle right now? How do you get comfortable that they have the financial wherewithal to be the partner that you need them to be through 2013 and beyond?" Dan Hesse gave a terse answer, saying that, "we'll continue to talk to Clearwire and work with Clearwire in that regard." Even though this statement is short, it does show that if necessary, Sprint will be there with a check. Dan Hesse is keenly aware that Clearwire is an integral part of his company's LTE strategy, and the infusion of capital from SoftBank will allow Sprint to assist Clearwire if it becomes necessary. Clearwire CEO Erik Prusch also stated on his company's earnings call that a financially stronger Sprint is a positive for Clearwire, given that Sprint is the company's strongest partner.
During the quarter, Clearwire burned just $28 million in operating cash, and we expect the company to continue to be prudent with its cash as it awaits the start of LTE prepayments from Sprint next year. While Clearwire certainly does have a need to be prudent with its cash, the company has over a billion dollars of cash and investments on its balance sheet, and its debts does not begin to mature until 2015. The following debt maturity schedule is from Clearwire's second-quarter 10-Q (the 10-Q for this quarter has not been released as of this writing, but the debt maturity dates will not have changed from quarter to quarter).
(click to enlarge)Do investors need to watch Clearwire's cash carefully? Yes they should. But, investors also need to remember that Clearwire is not in an imminent cash crunch, and by the time its debts begin to mature, the company will be in a much stronger financial position than it is today.
Corporate Governance: Does the Market Have it Backwards?
On October 17, minutes before after-hours trading ended, word broke that Sprint was working to gain control of Clearwire, sending Clearwire's shares up over 4% in a matter of minutes. However, the stock fell sharply the next day, as investors discovered that Sprint was simply taking control of Clearwire by buying Eagle River's stake in the company (Eagle River is the investment company of Craig McCaw, the founder of Clearwire). Investors assumed that this meant that Sprint was essentially gaining control of Clearwire's spectrum without the need to pay a premium to acquire all of the company's stock. However, upon closer analysis, it becomes clear that the convoluted equityholder's agreement that binds together Clearwire's strategic investors essentially makes this transaction irrelevant, for several reasons.
The first is that the Sprint/Eagle River deal could be challenged. As per the equityholder's agreement, Intel (INTC) (one of Clearwire's strategic investors) has received a right of first offer to buy Eagle River's stake in the company. Intel confirmed receipt of the offer on October 18, and it has 30 days to respond. Secondly, the equityholder's agreement leads to a rather ironic result, in which Clearwire becomes more independent if and when Sprint gains a majority stake. CEO Erik Prusch, in one of his relatively rare moments of transparency, took the time to explain these issues on Clearwire's Q3 call. He reminded investors that Sprint currently has the right to appoint 7 out of Clearwire's 13 directors, which, on the surface, would give Sprint control. However, all 7 seats are filled by independent directors, due to a 2010 decision by Sprint to reduce its control of Clearwire's board, ostensibly due to anti-trust concerns (and, we suspect, due to concerns about cross-default provisions in its debt). 12 of Clearwire's current directors are independent, and the 13th seat is filled by CEO Erik Prusch himself, serving as the appointee of Eagle River. Provisions in the equityholder's agreement require that seat to revert back to Clearwire if and when Eagle River sells its stake. CEO Erik Prusch stated on the call that, "the only change is that the Eagle River seat, which I hold, will be returned to the governance and nominating committee for the appointment of an independent director. As a result, Sprint will no longer be required to appoint an independent director to fill the seat presently occupied by the Chairman of the Board, John Stanton." Taking majority control of Clearwire's stock will give Sprint less control of the company's board. We believe that the market has misconstrued the effects that the purchase of Eagle River's stake by Sprint will have on Clearwire. And in any case, as CEO Erik Prusch stated, "Regardless of who appoints them, all of our directors in serving as public company directors continue to be bound by duties of loyalty and care and have fiduciary responsibly to all of our shareholders. [Emphasis added] Our commitment to the long-standing relationship we have with Sprint also has not changed, and we believe we continue to be integral to their future strategy and success." Over the past several days, we have received many messages regarding this issue, and we have been consistent in our response. Clearwire's board has a fiduciary duty to all of the company's investors, not just Sprint. Sprint cannot simply buy up whatever percentage of Clearwire that it wants and seize control of the company's spectrum, leaving all of the debt behind.
On its own call, Sprint deflected governance questions regarding Clearwire. However, Clearwire itself took some time to address other governance issues aside from the board. CEO Erik Prusch stated that, "I want to address some questions we've been getting about whether Sprint will need to consolidate Clearwire given their ownership will exceed 50% following the purchase of shares held by Eagle River. This is not a Clearwire issue. Implications of IFRS, or International Financial Reporting Standards, the international equivalent of GAAP, on the Sprint SoftBank transaction or local GAAP and the many changes that have occurred since Clearwire was formed in 2008 is an issue for Sprint to address with their auditors and is not for us to comment on." Any decision regarding the consolidation of Clearwire will, at a minimum, have to wait until Eagle River's shares are delivered to Sprint. This issue is likely to be further complicated by the fact that Sprint itself will become a subsidiary of SoftBank, and the relevant question is whether or not SoftBank will be required to consolidate Clearwire's financials. If Sprint owns 50% of Clearwire, and SoftBank owns 70% of Sprint, SoftBank indirectly owns 35% of Clearwire. This is where IFRS accounting standards become relevant, and the need to consolidate Clearwire's financials will likely be based on both GAAP and IFRS requirements. We expect more color on this issue once the Sprint/SoftBank deal closes.
We continue to believe that Clearwire's best days are ahead of it, and that a Sprint that is backed by SoftBank will be a positive for Clearwire. The company is continuing to execute on its LTE network deployment, and lowered 2012 capital expenditures will not derail those deployment plans. Investors also need to remember that even if Sprint's stake in Clearwire is brought above 50%, Clearwire's board will become even more independent, for the right to fill Eagle River's seat will go to Clearwire, not Sprint. And we would like to also remind investors in Clearwire that the company's board has a fiduciary duty to all shareholders, not just Sprint. Clearwire is working hard to deploy its LTE network, it has the cash to do so, and with a stronger Sprint as a partner, we believe that the bullish thesis regarding Clearwire is fully intact, and that shareholders will be rewarded in the long run for their continued belief in the company.