Sprint And Apple's iPhone: A Deal From Hell

| About: Sprint Corporation (S)

By Larry Gellar

While Sprint Nextel (NYSE:S) has been able to add subscribers by offering the Apple (NASDAQ:AAPL) iPhone, the company has also seen its costs skyrocket due to the device's large subsidies. Indeed, Sprint pays Apple a subsidy of $200 more per device than for the other phones it sells, which has caused a bit of a ruckus amongst shareholders. This led CEO Daniel Hesse to take a pay cut, and he plans on forfeiting some of his incentive pay so that his new compensation target opportunities will be set to what they were in 2010.

Here's how Daniel Hesse described the action in his letter to Sprint's human resources department:

These voluntary actions regarding my personal compensation, which total $3,250,830, will eliminate any benefit for me to the discretionary adjustment the compensation committee made earlier this year.

I'm always a fan of poor-performing CEOs taking a pay cut, but there are still a number of issues at Sprint to make me avoid buying this stock. On the other hand, for those already owning the stock, it may be better to ride out the storm and hope for the best. After all, the company's lack of profitability has brought the stock's price to book ratio (0.65) and price to sales ratio (0.22) to rock-bottom levels. Those ratios are lower than most other mobile telecommunication stocks including AT&T (NYSE:T), Verizon (NYSE:VZ), and MetroPCS (PCS). Of course, one reason why Sprint's ratios are so low is because the company is having significant problems with its margins. Those numbers are net profit margin of -8.58%, gross margin of 43.54%, and EBITD margin of 14.65%, and operating margin of 0.22%.

Needless to say, these margins are pretty poor, and Sprint may have even violated some laws in an attempt to improve them. Indeed, the law firms Powers Taylor, LLP and The Briscoe Law Firm, PLLC have announced that they are investigating legal claims against Sprint's management. Specifically, New York Attorney General Eric T. Schneiderman filed a complaint against the company, stating that it did not collect and pay over $100 million of state sales tax for its mobile services. Mr. Schneiderman alleges that this action was taken as part of a plan to reduce costs and gain a competitive advantage. Additionally, Willie Briscoe of The Briscoe Law Firm had this to say:

We are particularly troubled by the allegations of misconduct in the complaint and potential liability faced by Sprint. Based upon on our investigation, we are prepared to pursue litigation to preserve the company and the value of Sprint stock for all shareholders.

Despite Sprint's struggle to compete against the other mobile carriers, the company does have some solid products and services for businesses. For example, Sprint is expanding its Professional Mobility Services portfolio by introducing Sprint Device Management, which allows business to manage devices and device security even if they're running systems with different providers. In fact, a similar development is the new Sprint Professional Grade designation, which is awarded to smartphones with excellent security, management, and synchronization features. The new Sprint Device Management and Sprint Professional Grade designation could help Sprint gain traction in the business market going forward.

Sprint has had success in the market for government business as well. The company just won a 4-year, $2 billion contract to provide wireless products and services to the Western States Contracting Alliance. This consortium represents the state governments, local governments, and certain non-profit organizations for fifteen different states, so this deal should increase Sprint's presence significantly. According to Sprint's press release:

WSCA participants will be able to take advantage of the full suite of Sprint wireless products and services, including devices, unlimited data plans, accessories, applications and end-to-end solutions.

Shareholders can only hope that this contract paves the way for other deals of this magnitude.

Meanwhile, Sprint's latest earnings report was really a mixed bag. The company's Sprint segment added a net of 263,000 subscribers on contract-based plans, compared to a net of only 240,000 for Verizon Wireless and a net of 7,000 for AT&T. (Note that these numbers exclude tablet data plans). That was crucial for Sprint to justify its 4-year, $15.5 billion commitment to Apple for the iPhone. Sprint activated slightly fewer iPhones in the fiscal first quarter than in the quarter before that, but the 1.5 million activations is still a very large number, obviously. Overall, wireless service revenue was up 7.4% year-over-year basis, impressive considering AT&T's growth was only at 4.3%. Still, Sprint is lagging Verizon in this regard, which recently reposted a 7.7% year-over-year increase. Furthermore, Sprint is still dealing with its Nextel issue, the outdated network that is losing customers rapidly and scheduled to be shut down next year. Right now, the game plan is to use Nextel's old radio frequencies for a new 4G network, which will allow Sprint to become less reliant on Clearwire (CLWR).

By depreciating the value of its Nextel network, Sprint posted a loss of 29 cents per share, not quite as bad as the loss of 42 cents per share that analysts were expecting. Revenue, too, managed to pull ahead of analyst predictions but only slightly. With only $978 million of operating cash inflow during the first quarter, Sprint has a long way to go before being financially solid. And for those investors seeking dividends, the decision is easy - go with AT&T or Verizon, which offer 5.3% and 4.9% dividend yields, respectively. On the other hand, I would have to recommend current Sprint shareholders simply sit tight instead of selling. If Sprint does pull off a turnaround, the stock should appreciate significantly due to its already extremely low valuation.

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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