Sprint's Long-Term Corporate Evolution

| About: Sprint Corporation (S)
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Sprint Nextel Corporation (NYSE:S) is continuing its long-term evolution as a telecom company. Sprint's progress in overcoming the strategic and operational mishaps of the Nextel merger have impressed us so much that we added to our position last month. We were blown away with the fact that revenue growth on the Sprint platform (excluding Nextel run-off) was 16% for the second straight quarter, far exceeding the collective growth of Verizon Communications (NYSE:VZ) and AT&T (NYSE:T). Moreover, Sprint Nextel's wireless platform (including Nextel run-off) grew by 8.25% last year, which edged out Verizon's 7.8% growth.

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Sources: Wireless Company Q2 Earnings Releases

Areas we would like to see improvements

We were disappointed that losses and capital expenditures increased on a year-over-year basis. However, 119% of the increased losses related to non-permanent events involving the Network Vision program. The company incurred a one-time lease termination charge of $184M and incurred $661M of accelerated depreciation related to the company's planned shutdown of the Nextel iDEN platform. Sprint accelerated its Nextel site shutdown program and shut down 9600 Nextel sites in the first half of the year, which was six months ahead of schedule. We are glad to see that this program is succeeding ahead of schedule.

We also rationalized the increased capital expenditures were due to Sprint's Network Vision Program. In Q1 2012, the company brought 600 sites on air and added another 1400 in Q2 2012. Sprint continues to expect to bring approximately 12,000 sites on air by the end of 2012. Sprint launched 4G LTE in five major cities (Dallas, San Antonio, Atlanta, Houston and its home territory of Kansas City) on July 15th. We are intrigued with Sprint launching 4G LTE in Dallas, San Antonio, Atlanta, and Houston, as we previously pointed out that three of those cities have served as the headquarters for AT&T, its predecessor Southwestern Bell and its wireless business. Also the increased CapEx has helped support Sprint's iPhone sales efforts

We are displeased that the postpaid Churn rate is still higher than AT&T's and Verizon's. However, it improved to 1.79% for this quarter, versus 2.01% for Q1 2012 1.98% for Q4 2011 and 1.81% in Q1 2011. We were pleased that pursuant to management guidance in Q1 2012, the elevated churn levels seen in Q4 2011 and Q1 2012 have come down. Sprint Platform churn was 1.69% for the quarter, an improvement of 31bp sequentially. We continue to expect improvements in voluntary churn longer-term, driven by the ongoing improvement in Sprint's customer experience and the iPhone.

We are disappointed that even though Sprint has the least expensive data plan, Sprint only sold 1.5M iPhone devices versus Verizon's 2.7M or AT&T's 3.7M. However, we're glad that Sprint saw no linked quarter sales decline, unlike Verizon and AT&T.

Sources: Wireless Company Q2 Earnings Releases and Conference Calls

Areas we can see that progress is being made

Despite selling 1.5M iPhones from Apple (NASDAQ:AAPL) that carry $450 subsidies per phone, Sprint actually made $318 in increased profits versus last year's performance, excluding previously identified non-recurring expenses; 40% of iPhone sales were to new customers and over 16% of its postpaid client base now has Apple's cutting-edge, easy-to-use iPhone smartphone. We find that this compares favorably to the 25% for Verizon and 22% for AT&T. Earlier this year, analysts raised concerns that Sprint won't be able to satisfy its purchase commitment of $15.5B over a four year period to Apple.

Sources: Wireless Company Q2 Earnings Releases and Conference Calls

We ran a quick estimate in which we assumed that all 4.8M iPhones Sprint sold were the low-end iPhone 4 model at $550 wholesale cost and we estimated that Sprint has spent at least $2.64B on Apple iPhones; at this pace Sprint will be able to meet 91% of the contract assuming sales volumes remain constant. We expect that Sprint has sold an assortment of higher-end iPhone 4S models and that iPhone sales will steadily increase as people see Sprint's improvements in customer service. Furthermore, now that the company is selling the iPhone device to its Virgin Mobile customers, we have greater confidence that iPhone sales volumes continue to show growth.

The company has no Debt Redemptions until May 2013 ($300M) and October 2013 (473M). Earlier in the year, Sprint bulked up its cash position with a $2B bond sale on March 1, 2012 at a weighted average coupon of 8.0625%. Since Sprint generated positive free cash flows of $209M year-to-date, it did not need to tap the bond proceeds so far this year. Sprint also prepaid $1B of outstanding bonds that were maturing in 2013. Gross cash and short-term investments were $6.8B as of Q2 2012 and the company also has a $1.2B bank line of credit as well as a $1B equipment purchase credit line from Ericsson (NASDAQ:ERIC).

We're glad Sprint's Board of Directors vetoed Dan Hesse's $8B proposed acquisition of MetroPCS (PCS) back in February. We believe that with the progress Sprint has made in its evolution as a company, we believe that it could look at potential acquisitions next year such as MetroPCS or Leap Wireless (LEAP). We believe that at the right price, Sprint could and should acquire MetroPCS or Leap Wireless. We believe that these additions would work out much, much better than the Nextel deal for the following reasons:

  • Sprint and Nextel were large wireless communications companies, MetroPCS and Leap are much smaller in terms of revenues
  • Sprint and Nextel were full-service wireless communications companies (prepaid and postpaid), MetroPCS and Leap are focused on prepaid exclusively.
  • Sprint and Nextel were trying to make a "merger of equals" work, if Sprint acquired Leap or MetroPCS, it would be clear that Sprint is the surviving platform
  • Sprint's legacy network was 3G-CDMA while Nextel's was 2G-iDEN. MetroPCS and Leap are both on the CDMA network. In addition to Sprint's recent upgrade to 4G-LTE, MetroPCS has also begun its efforts to migrate to 4G-LTE and Leap announced a 4G-LTE agreement with Sprint's Clearwire (CLWR).
  • An additional synergy would be the massive scale that the combined company enjoys in the prepaid segment. Sprint has 15.4M prepaid customers and 8.4M reseller customers. MetroPCS has 9.3M customers and Leap has 6.2M.

Though Sprint saw a quarterly decline in postpaid subscribers by 246K, we noticed that the net decline came mainly from the Nextel platform. The Sprint postpaid platform added 442K net subscribers, primarily from retaining Nextel customers. Sprint reported that it was able to retain 60% of 46% of Nextel's postpaid churn during the quarter, up from 46% in the linked-quarter period and 27% in the prior-year period. Even if all these customers added to the Sprint platform were previously Nextel shareholders, we find that to be positive because Sprint only has four more quarters of Nextel run-off to go through. Thanks to the addition of the iPhone, postpaid ARPU has increased by 6.6% year-over year.

Sources: Wireless Company Q2 Earnings Releases and Conference Calls

While Verizon was the undisputed leader in Q1 postpaid adds, the Sprint platform managed to gain more postpaid contract customers than AT&T.

Sources: Wireless Company Q2 Earnings Releases and Conference Calls

We can see that Sprint's majority owned affiliate Clearwire had reduced losses versus the year ago period as Sprint's equity investment losses declined by nearly $190M versus the prior year period. Clearwire also signed Leap Wireless's Cricket Wireless brand to a 5-year wholesale LTE network agreement.

In conclusion, we are glad that we added to our position in Sprint and we believe that investors should steadily accumulate shares of the company, especially during down days in the market. Sprint's improved customer service experience has yielded positive, tangible results, especially with regards to retaining legacy Nextel customers.

We don't even think of the company as Sprint Nextel any more, we think of the company as Sprint and we expect the company to change its holding company name back to Sprint next year when Sprint completely shuts Nextel down. Sprint even began reporting connected devices as a separate business operating metric. Though Sprint's 3.17M in connected devices customers is smaller than AT&T's 13.3M, we believe that Sprint has the potential to improve its results here as well. On a linked-quarter basis, Sprint's 5.4% growth in connected devices was more than triple AT&T's 1.76% growth. Sprint was able to achieve this without the benefit of the hot selling iPad device.

Finally, the reason why we are recommending investors purchase Sprint versus any other wireless company, particularly Verizon and AT&T is because the Sprint platform offers the lowest cost for postpaid smartphone customers due to AT&T's and Verizon's new "shared data plans".

Disclosure: I am long S, AAPL.

Additional disclosure: Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this report. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.