Opposition Against Sprint CEO Grows

| About: Sprint Corporation (S)
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In late February, I wrote an article asking if it was time for a change in leadership at Sprint (NYSE:S). At that time, the Sprint board had just knocked down a deal to buy out MetroPCS (PCS). Questions arose whether or not CEO Dan Hesse had support from the company's board, so it was a logical question to ask.

On Tuesday morning, opposition to Mr. Hesse grew. The Ontario Teachers Pension Plan, which has about a 4% stake in Sprint, announced its intention to vote against re-electing Hesse to Sprint's Board of Directors. Despite a recent announcement that Hesse would cut his pay, the Pension Plan was not satisfied, arguing that there were "poor linkages between company performance and senior management pay." Why do they feel this way? Let's look at the current situation involving Sprint.

As I recently covered Sprint's Q1 earnings report, here are some of the main takeaways:

  • Sprint's Q1 loss doubled from 15 cents per share in 2011 to 29 cents per share in 2012.
  • In the past 17 quarters, Sprint has lost $12.5 billion dollars.
  • Activations of Apple's (NASDAQ:AAPL) iPhone were 1.5 million in Q1, down from 1.8 million in Q4. While that wasn't as bad a drop-off as we saw with Verizon (NYSE:VZ) or AT&T (NYSE:T), Sprint's commitment to Apple is for 7.5 million phones per year. They have sold just 3.3 million in the first six months.
  • Total additions were 1.1 million in Q1, compared to 1.6 million in Q4. Postpaid additions dropped from 539k in Q4 to 263k in Q1.

Those are just some of the highlights. Sprint went all-in when it agreed with Apple to sell the iPhone, and we are starting to see the effects. Just look at how Sprint's margins have dropped (year over year) in the two quarters since it got the iPhone. The iPhone is expensive, and it is taking a large chunk out of Sprint's gross margins.

Margins Q4 2010 Q4 2011 Q1 2011 Q1 2012
Gross 46.28% 43.54% 47.12% 41.78%
Operating -1.83% 0.32% 3.12% -2.92%
Profit -10.64% -8.58% -5.28% -9.88%

Now, you may look at that table and say wait a minute, things improved in Q4 from 2010 to 2011. While that is true, you have to look at the trend. Look at the following table. Sprint was doing much better in the year over year numbers for Q3. They were really improving their margins. Since they started selling the iPhone early in Q4, things have actually gotten worse. The table shows the year over year change in each margin category, from 2010 to 2011 (or 2011 to 2012 for Q1).

Margin Impact Q3 Q4 Q1
Gross -0.18% -2.74% -5.34%
Operating 5.11% 2.15% -6.04%
Profit 7.56% 2.06% -4.60%

We all knew that Sprint's $15 billion plus deal with Apple would be expensive, but how much longer can this company continue to lose billions of dollars per year? Remember, Sprint is working the deal with Apple while it undergoes a $7 billion dollar network upgrade. A large portion of Sprint's network and its future rely on Clearwire (CLWR), a company that itself is struggling mightily.

Prior to Q4 of 2011, Sprint had a huge investment in Clearwire, and it was losing millions of dollars per quarter in that investment. In late 2011, Sprint and Clearwire announced a new deal, which made Sprint pour even more money into Clearwire. Sprint owns billions in Clearwire debt and in equity. Clearwire's equity has lost even more value in Q1, and if Clearwire's financial troubles continue, Sprint's debt holdings could become worthless. That is just the monetary investment.

All of this has helped to increase the huge debt pile on Sprint's balance sheet. At the end of September, Sprint had $18.5 billion in long-term debt outstanding. Since then, the company has taken on about $6 billion in new debt, while retiring about $2 billion that was due early in 2012. Unfortunately, most of the new debt has higher interest rates than the debt that was retired.

Not only are Sprint's interest costs rising (on the income statement), but Sprint is getting hit with higher interest rates on new debt. Sprint doesn't have any debt due until 2013, but even with that debt, Sprint was paying less than 7% interest. Most of the newer debt is facing 8%, 9%, or higher, interest rates. The company may even need to add more debt going forward.

It isn't a surprise that Sprint's shareholders are starting to get frustrated. Even in 2011, a down year for both, AT&T had a nearly $4 billion profit and Verizon had a $2.4 billion profit. Both of those companies are paying dividends in excess of 5% annually. Sprint is losing billions, and paying no dividends.

So how much longer can Hesse hold on? Well, if conditions don't improve, I'm guessing he doesn't have more than a year. More shareholders are going to get angry if the losses continue to pile up, and the board was already mad at him for trying to force through the MetroPCS deal.

Hesse has lessened subscriber losses since he took over, but I'm guessing many were expecting that Sprint would be in much better shape financially by now. The company is still expected to lose $4.5 billion this year and another $3 billion or so next year. I still think this stock can go lower, and it might take a change at the top for it to finally find a bottom.

Disclosure: I am long AAPL.