Sprint Deems Clearwire Too Big To Fail

Includes: S, T, TMUS, VOD
by: SR Capital

Sprint (NYSE:S) has been treating Clearwire (CLWR) like a red-headed stepchild recently, but the new agreement announced December 1st affirms what many of us already knew – that Sprint is heavily dependent on CLWR and will do whatever it takes to ensure that CLWR succeeds.

You can find the press release announcing the agreement here.


CLWR has by far the strongest spectrum position of any U.S. wireless operator, and spectrum is the key to meeting the exploding demand for wireless bandwidth as our smartphones and tablets gradually replace PC’s. CLWR is primarily a wholesale provider of such bandwidth, and Sprint is by far its largest customer (and roughly 50% owner). But to fully leverage this spectrum, CLWR needs to migrate from its current WIMAX network to an LTE network that will be compatible with the rest of the industry. And to do so, they need to raise approximately $1 billion in debt and equity. Furthermore, management has said that they needed to raise $300 million by the end of 2012 just to avoid running out of cash. With over $4 billion of debt, perceived bankruptcy risk is the primary reason that CLWR is down over 50% year-to-date.

Sprint is highly dependent on CLWR for its future success (and very survival, in my opinion) as Sprint does not own enough spectrum to compete with Verizon and AT&T. In addition, roughly 15% of Sprint’s customers (over 8 million subscribers) are using CLWR’s network for unlimited 4G (i.e. high speed data) service, and that number grew by 29% in the third quarter alone (that’s a 116% annualized growth rate). Sprint would have lost an estimated 500,000 subscribers in the third quarter if not for the roughly 1.8 million customers that signed onto Sprint specifically for access to CLWR’s 4G network.

Combine these facts with Sprint’s anemic retail subscriber growth, heavy debt load (and recent downgrade by the ratings agencies), a multi-billion network upgrade pending, a multi-billion dollar obligation to Apple to subsidize iPhones, and a stock price that is down almost 90% from its peak in 2007, and it seems clear that Sprint needs some bold moves to survive.

So what’s the good news? CLWR owns the most important strategic asset in the industry today, and Sprint owns nearly 50% of the company. CLWR’s spectrum position, combined with the upgrade to LTE, would give Sprint the “fattest pipe” in the industry and allow it to leapfrog AT&T and Verizon in terms of the services and pricing that it can offer, putting it in a position to dramatically improve market share.

Against this backdrop, Sprint and CLWR have been locking horns over network pricing and terms. The stock prices of both companies have been falling precipitously as the markets monitored the domestic dispute (at times public and often ugly) with a combination of amusement and disgust. It was a classic mutually assured destruction scenario, but both sides appeared to have dug in their heels and the outcome seemed uncertain.

New Sprint Agreement

But on December 1st, Christmas came early for beleaguered CLWR shareholders. With CLWR threatening to skip an interest payment and eliminate Sprint as an owner via bankruptcy unless they came to the table with some support, an agreement was announced that paves the way for CLWR to survive in its current form and for both companies to become leaders in the U.S. wireless industry.

Early press reports are focusing on the extension of the existing WIMAX agreement beyond 2012 (this was always a no-brainer with so many of Sprint’s customers on CLWR’s network) and Sprint’s commitment to fund nearly 50% of any equity raise (also not a surprise given their ownership stake). However, the key to CLWR’s future lies in the following excerpt from the press release: “The agreements also establish long-term usage-based pricing for LTE services for 2012 and beyond.” By fixing pricing, Sprint is allowing CLWR to create a credible forecast of LTE-related revenue and cash flow that it can use to attract the vendor financing and equity investment required to build the LTE network. In addition, Sprint’s agreement to prepay up to $350 million for LTE capacity firmly establishes itself as an anchor customer on CLWR’s LTE network.

Please note also that the press release states the LTE pricing structure will be "usage-based", which is important for CLWR because demand for bandwidth continues to outpace even the most aggressive forecasts. CLWR won this crucial point by converting WIMAX pricing to a fixed amount for unlimited capacity for two years, which will make it easier for Sprint to maintain its Unlimited plans for its existing 4G customers. This was probably the most contentious point in the negotiations, and in my opinion CLWR got the better end of the deal.

Furthermore, the agreement represents a significant thawing in relations between these co-dependent partners. If there was ever any doubt, it should now be obvious to all that Sprint will not let CLWR sink into bankruptcy.

Implications for Investors

It will take some time for the markets to digest the new information. We still need further guidance from CLWR management on exactly what they expect 2012 to look like from a cash flow perspective, and we don't know how dilutive the equity portion of the capital raise will be, athough I believe this risk is limited.

Management has indicated that they believe they can raise equity and vendor debt in equal proportions, so I expect them to raise approximately $500 million of each.

The dilution question may loom large for some investors but I think the downside here is limited. If the Company raised $500 million in equity at $2 per share, investors would be diluted by just over 20% - this is a small price to pay for a stock that is trading far below the liquidation value of the spectrum (see below).

I believe the more likely scenario is a rights offering (at a price significantly in excess of $2) that at least gives shareholders the ability to avoid dilution by participating - the company has done this before. Bear in mind there are several large strategic investors (including Comcast, Time Warner Cable and Google) that aren't going to stand by and let Sprint (or a new investor) dilute everyone else, especially now that there is a clear path to profitability.

Too Big to Fail

Most importantly, this agreement leaves no doubt that CLWR is “too big to fail” from Sprint’s perspective. This will keep CLWR out of the bankruptcy courts, and CLWR investors can once again rely on the value of their massive and highly strategic spectrum holdings to provide a healthy floor on the break-up value of the stock.

Downside Protection, Upside Potential

I believe an orderly sale of the spectrum could fetch $8 per share – this is less than half of the lower end of the range of values suggested by CLWR management and is well-supported by comparable transactions. This represents nearly 4x the current stock price and doesn’t even require management to execute the business plan.

But spectrum value aside, the new agreement paves the way for Sprint and CLWR to use their dominant spectrum position to challenge Verizon and AT&T for supremacy in the huge (and still growing) market for wireless services. If they stay on this path, CLWR could provide a 10-20x return to shareholders over the next five years.

Disclosure: I am long CLWR.