Sprint: Great Value or a Value Trap?

Includes: DTEGY, S, T, VZ
by: Jake Huneycutt

With AT&T's (NYSE:T) acquisition of T-Mobile over the weekend, there is perhaps no stock that becomes more intriguing now than Sprint (NYSE:S). As I write this article, Sprint has suffered a devastating 16% decline in its stock price as a result of AT&T’s acquisition. While I would attribute this largely to market irrationality, on one hand, that doesn't necessarily mean that the case for buying Sprint is that strong, either.

I have followed the back-and-forth on Sprint for about a year now and I have analyzed the company myself a few times. Yet, I've never been able to come to a strong conclusion one way or another.

Amongst hedge funds, David Einhorn's Greenlight Capital appears to be the most bullish on the stock. Financial blogger Chad Brand has recently posted a bullish case, as well. Chad Brand believes that Sprint is recovering and that the company still has many small acquisition targets available; which he views as more suitable targets for the company than T-Mobile.

Interesting enough, Amit Chokshi of Kinnaras Capital Management made a bullish case for the company last May, but has now reversed course and sold out of his firm’s Sprint position. Chokshi believed that the company had ‘hidden value’ in its assets and that introduction of the HTC Evo 4G could give it a leg-up on the competition. He has since lost faith in the management team, the marketing efforts, and the company’s inability to take advantage when it was ahead of its rivals on 4G.

The Positives for Sprint

There are quite a few positives that highlight the case for buying into Sprint:

  • Sprint is making a small turnaround right now. In Sprint’s last earnings call, CEO Daniel Hesse pointed out Sprint’s strong growth in postpaid wireless customers, up 2.7 million from the prior year. While overall revenues have stayed level, operating losses have declined over the past three years.
  • Free cash flows are strong. Even though earnings look poor, free cash flows [FCFs] are actually still fairly strong for Sprint. FCFs have hovered in the $2.8 - $3.0 billion range over the past three years. If FCFs are a more accurate measure of earnings, S might be making about $1 per share right now, suggesting it should be priced closer to $10 - $15, rather than $4.25.
  • T-Mobile Acquisition Eliminates Competition. Everyone seems to think the AT&T / T-Mobile deal hurts Sprint, but it actually eliminates competition for them. Moreover, it could create a large pool of T-Mobile customers who have no real loyalty to AT&T and decide to shop around between T, S, and Verizon (NYSE:VZ).
  • Verizon might want to acquire Sprint. The AT&T / T-Mobile deal might push VZ into trying to acquire S.
  • Undervalued Assets. While Sprint’s book value is only in the $3 - $4 per share range, many of their assets might be substantially undervalued. It’s also worth noting that accelerated depreciation might have a significantly distortive impact on the asset values on the balance sheet. Hence, if Sprint’s book value were completely marked to market prices, it’s possible that the company would look worth more than it might be on paper.
  • Reasonable Shape. Also worth noting is that Sprint’s strong cash flows, growing cash position, and potentially undervalued assets suggest that the company is still in relatively good shape financially. So even if they appear to be churning out losses, they can probably absorb them without too much difficulty in the near-term.
  • Upside Potential is Notable. One thing I like to look at with stocks in the upside potential vs. the downside. While it’s difficult to predict Sprint’s downside (as it would depend on one’s time frame), the upside appears to be rather sizable. If management were successful at turning the company around, margins were to improve, and the company became more competitive with AT&T and Verizon, there could be significant upside for the stock. This is, of course, a lot of “ifs”, but all the same, upside could be in the $20 range, or about a 375% gain from the current price. Even if the company is only moderately successful in a turnaround, $10 - $15 is not out of the question, for a gain in the 125% - 250% range.

The Negatives for Sprint

In spite of some of the positives that might suggest the company is undervalued, there are just as many, if not more negatives that might continue to frustrate the bulls.

  • Sprint’s marketing failures. Sprint's commercials are even worse than AT&T's and Verizon's. I don't normally put too much stock in advertising, but I find Sprint's commercials to be downright stupid and they don't really make any reasonable case for switching to Sprint. This might not seem like a big deal, but how many people can honestly say they decided to ‘check out Sprint’ because of the marketing campaign? There are no real facts in their marketing efforts that actually sell the customer on why Sprint is better for them. While I’ve never been overly impressed with AT&T or Verizon’s commercials, either, both companies at least seem to know what they have to offer and what they are selling to consumers. You can’t say the same thing about Sprint. That’s troubling to me.
  • Management and (Lack of) Growth. I'm not sold on management. They are spinning this 'giant turnaround', but the numbers aren't really backing them up. There appears to be some minor progress, but revenues are flat, and operating losses have only decreased because depreciation expenses have declined. On a free cash flow basis, the company appears to be flat. More troubling to me is the way management spins this as great progress, which suggests that they might not be holding themselves accountable for problems in the company.
  • CapEx. Sure, Sprint's FCFs look great, but why are they investing so much less in CapEx than their competitors? In the charts below, I have examined CapEx for S, VZ, and T over the past three years and compared it to revenues and depreciation. Notice anything strange?

While I do not claim to be much of an expert on the telecom sector, my initial impression based on those figures alone is that Sprint is not investing nearly as much in the future of its business as AT&T and Verizon. The chart below shows the same info, as above, but the results are compared more clearly:

Why are AT&T and Verizon investing so much more in capital expenditures? Does this mean that Sprint’s primary strategy right now is to try to milk as much as it can out of its current assets, but slowly allow the business to die over time? I’m not really sure, but I find these numbers odd and potentially troubling.

  • Massive insider selling at S. Ok, sure, this is a large-cap company and execs in large companies rather not throw all of their capital into one stock with limited growth potential; I get that. Can you fault execs for doing that? But some of the share dumpings are, in many cases, quite large. There’s also the Daniel Schulman factor here; as Schulman left Sprint to go to American Express (NYSE:AXP); so he distorts the number a bit. Yet, still … I just find it hard to believe that these execs and ex-execs truly believe the company can be turned-around. If the stock theoretically has about 100% - 400% upside, it would at least appear to be a good value if one had faith in the thesis. Maybe this is a bit of an off-target criticism, but it doesn’t give me a lot of faith that some of the people closest to the situation don’t have much faith. On the plus side, at least the CEO, Hesse, has held onto most of his holdings.
  • Sprint’s website. Take a look at Sprint's website compared with AT&T, Verizon, and T-Mobile. Look at the "plans" sections, in particular. If any company ever had a vision that contrasted with Apple’s (NASDAQ:AAPL) simplicity in design, it would have to be Sprint. Reading through their phone plans is like reading through a giant catalog. It’s not so much that there are an abundance of plans, so much as they don’t bother to lay it out in any way that’s useful for the customer. Can anyone seriously tell me that Sprint's "plans" section is well laid out and easy to understand vs. the competitors?
  • The dreaded “brand”. Management seems to be obsessed with using the word “brand” and talking about “re-branding” strategies. In fact, scanning through their latest earnings call transcript, I found the phrase came up at least 15 times! (And that was without searching for the variations of the term.) This might seem neither here nor there to most people, but it strikes me as a sort of shallow resort for poor management. When things go bad, there’s always a lot of talk about ‘re-building the brand’ and the ‘importance of re-branding’. These are all meaningless phrases and emphasize to me that management might not have more concrete plans on how to improve the fundamentals behind their business. Talking about ‘strengthening the brand’ is simple because no one can really measure something like that accurately.
  • Regulators. While the AT&T / T-Mobile deal might make Sprint more tempting to Verizon, I wouldn't exactly bank on US regulators approving such a transaction. At this stage of the game, AT&T and Verizon control a massive share of the market and even if regulators eventually do approve the AT&T / T-Mobile deal, I would not say that it’s a sure thing they’ll approve a Verizon / Sprint deal. Hence, Sprint might be stuck; either they have to improve business or slowly decay.

What’s the Balance?

Taking into account all these positives and negatives, I do believe that Sprint may be undervalued right now. In particular, the argument that they have undervalued assets seems to have some grounding, and this would make the company worth significantly more than it might appear on paper. All the same, unless they can truly turnaround their prospects, attract more subscribers, and gain market share, without completely sacrificing their margins, this will remain a decaying business.

With uncertain regulatory prospects surrounding a future acquisition, Sprint’s only out might be to sell off to an ambitious private equity investor. Or perhaps there is a company outside the telecom business that might see some value in its assets. Still, it’s certainly not clear that there is automatically a potential acquirer that can nab up the company.

The upside might make this attractive, but nothing about Sprint’s current moves really impresses me. I can understand the bull case, but I’ve decided that in spite of the potential upside, I’d rather stay away from this one.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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