Sprint Nextel (S) has found a white knight in its acquirer Softbank. The number three U.S. carrier did not need to be saved from another suitor, however, but its own strategic miscues. Struggling under $14.5 billion in debt, Sprint's build-out of its Long Term Evolution (LTE) network is back on track. By selling a 70 percent stake to Softbank, Sprint has acquired $8 billion in much-needed cash and the credit to push up to $9 billion in bond payments out into the future. Even with the cash infusion, the former first mover in 4G networks has to win market share from stealthier movers, namely Verizon (V). Assuming Softbank's large cash reserves can reverse Sprint's fortunes underestimates how ruthless the game of first mover advantage, once lost, can be.
In LTE networks, Sprint is coming from behind. Its efforts to be the first mover in high speed network infrastructure has made it a laggard. If WiMax had prevailed in the 4G market, Sprint could have owned the market. But first mover advantage is a much higher risk strategy in a market characterized by rapid technological innovation. Vacuum maker Hoover is an oft-cited example of how a first mover can triumph when the pace of technological innovation is slow. Innovation in high speed data networks, in contrast, moves very fast. With the ability to move data across new 4G networks at up to 10 megabits per second (mbps) at higher revenues per customer, the build out of LTE networks is happening at a blazing speed.
In markets in which technological innovation is moving fast, a lot of cash is required to keep up, and Sprint ran out of cash. When 4G WiMax was first deployed in 2006, it offered the potential to move data at twice the one megabit speed of 3G networks. LTE offers download speeds at three times the rate of WiMax. To its credit, Sprint has wasted no time cutting its losses and adopting LTE technology. Softbank's deep pockets can finance Sprint's LTE network, but can Sprint regain the market share of a first mover?
Sprint's fuller embrace of LTE by scrapping the WiMax network and building its own LTE network, in lieu of leasing LTE access from Clearwire (CLWR), is a late move. A newly cash-fortified Sprint will have to unseat some of the market share of Verizon, the first mover in LTE. Having deployed LTE in over 400 markets, Verizon now commands 66 percent of the U.S. LTE market. No matter how stealthily Sprint executes on LTE, it will be hard to catch up to Verizon. Barring technological innovation, on par with LTE usurping WiMax, Sprint will be competing hard on price and value added products and services for LTE market share.
Building out an LTE network with Softbank's cash may still be a tight maneuver. Sprint's shrinking cash reserves fell to under $4 billion before the Softbank acquisition. Softbank has provided another $8 billion in cash. Meanwhile, as Verizon and AT&T (T) ease up on capital spending as their LTE networks near completion they are enjoying growing cash flow from operations at $30 billion and $15.1 billion, respectively. Softbank's cashflow from operations at $9.2 billion, hovering slightly above the $7.6 billion average of the capital intensive wireless communications industry, is well below some of the larger mobile operators, such as China Mobil (CHL) at over $30 billion and Vodaphone (VOD) with over $20 billion in cash.
Sprint's push forward with its own LTE network is not only about higher speeds and revenues but costs. Sprint is selling LTE-enabled equipment. It either has to continue to lease LTE networks from Clearwire or other operators such as Verizon, or build its own network. Currently, Sprint is in the process of buying Clearwire, which will be part of its LTE network expansion from 32 to 140 cities next year. Sprint still has to pay down debt on its WiMax network, which will soon be shut down and no longer be generating revenues.
Wireless operators can charge a premium for LTE services, as high as 20 percent, to subscribers whose demand for LTE data services is forecasted to grow at a compound annual rate of 50 percent over the next five years. But can Sprint attract enough subscribers to make LTE profitable? Number two LTE player AT&T's third quarter results provide a glimpse of the competition ahead for Sprint. AT&T, adding 151,000 customers to its wireless network in the third quarter, experienced a 3 percent decline in wireless margins year-over-year while Verizon saw a 2 percent expansion in profit margins on subscriber growth of 1.5 million. We have not done the math to figure out the subscriber breakeven point for Sprint. By 2014 there will be more LTE network operators competing for subscribers.
Despite the tough odds, Softbank is the one company that could beat them. Following 50 acquisitions over the last decade, Softbank's return on assets at 6.6 has been increasing year-over-year. Turnarounds to its credit include Vodaphone Japan and Japan Telecom. The Japanese telecom and internet service provider's operational strength is evident. It has consecutively increased revenue and earnings over the last five years while expanding margins and reducing debt. The company has taken on high debt to acquire Sprint. Applying its turnaround expertise is part of its strategic plan for its Sprint buy.
Softbank's LTE technology may be Sprint Nextel's real turnaround ticket. Sprint could still make a strong comeback in 4G networks over Softbanks' 18 mbps LTE network technology, operating at almost twice the speeds of competing networks. We cannot rule out Verizon, AT&T and others increasing their network speed, but currently, Softbank's LTE is a real trail blazer on speed. Deployment of this faster network in the U.S. could help Sprint Nextel gain a profitable, and possibly dominant share of the LTE market. Technological innovation is one surefire way of gaining first mover advantage.