Sprint Nextel Moves Deeper into the Red

Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sprint (NYSE: S) disappointed the market with lower than expected results for fiscal year 2012. With the Sprint-Softbank acquisition taking a new turn and commitment to Apple not proving to be a good deal, things may not be as hunky dory as they seemed when the deals were first announced. Billionaire Masayoshi Son, Softbank’s founder, is offering Japanese householders 50 times more yield on bonds than other deposit accounts to fund the $20 billion acquisition.

Valuation Summary

  • The mobile internet SBU contributes 59% to the overall revenues
  • The mobile plans and phones contributes 25% to the overall revenues
  • Landline business contributes only 13% to the overall revenues

Competitor Highlights

Sprint primarily competes with AT&T (NYSE: T) and Verizon (NYSE: VZ). AT&T deals in mobile plans, phones and internet TV. Its current market cap is $202 billion, and it generates more than half of its revenues through the mobile plan business segment. It recently announced a $1.9 billion offer to acquire spectrum licenses in 18 states. Verizon operates in a similar market of mobile phone plans, phones and broadband services. It has a market cap of $126 billion and it generates a high level of revenues through the mobile plans and phones segment.

Disappointing Results FY 2012

Sprint's total revenue for the year barely grew by 3% to $9 billion; however, earnings took a major hit when it reported a loss of $4.3 billion. The increase in the number of postpaid subscribers fell sharply compared to 2011. In addition, the company had a jaw-dropping decline in cash from existing operations. The figure came down to $216 million from $1.1 billion in the 4th quarter of the previous year. The CAPEX of the company increased considerably, which has led to negative free cash flow. This may reduce the EV (Enterprise value) going forward.

Commitment to Apple a Risky Move

Commitment to Apple is proving to be a risky move for the carrier, as it is losing a considerable amount of post paid subscribers, a trend that may continue. Although Sprint is adding subscribers, the losses incurred by Nextel are overshadowing the gains. Sprint is consistently losing market share to other carriers, and a four year commitment to the iPhone is proving costly. The iPhone is currently facing intense competition in the smartphone market, and going forward may give up some of its market share to its cheaper competitors. Furthermore, the long-term debt on the balance sheet of Sprint is nearly $24 billion. This puts Sprint in a highly dubious situation, considering it may incur more expenses if it is unable to meet its debt obligations.

Importance of Softbank Merger

Sprint has been consistently losing ground to the likes of AT&T and Verizon. It has now become absolutely crucial for the Softbank merger to go through, as Sprint is in need of capital in order to survive in the face of such fierce competition. Market share in the post paid segment has been declining consistently, but if the Softbank merger goes through it can then provide Sprint enough cushion to compete with the big boys.

Trends Going Forward

The 2011 market share for Sprint CDMA is roughly 9%, and I expect it to grow approximately 11% by the end of 2012. The potential drivers behind the growth could be users gradually making the transition to CDMA from iDEN. CDMA (Code Division Multiple Access) is the post-paid wireless customer base of Sprint prior to its merger with Nextel. Sprint had a healthy growth in its market share until 2007. However, since the merger the services standards have dropped significantly, leading to many subscribers making a shift to AT&T and Verizon. The commitment to the iPhone initially helped Sprint, but the fierce competition the iPhone now faces in the industry is not helping matters.

If the market share grows as expected there could be a 30% upside to the current trading stock price, but if it fails to capture more market share then there could be a 30% downside. During 2011, the SG&A was approximately 54% of gross profits, and going forward if this figure stays below the 60% mark, then we could see a 20% to 30% upside on the stock price. Nonetheless, if the SG&A cost jumps above 60% then we may witness a huge dive in the stock price. Another key trend that must change for Sprint to rebuild itself is the Internet & SMS Revenue per Sprint Mobile Subscriber. This is a crucial facet of its business model, as it refers to the revenue generated through non-voice communication such as SMS (Text Messages) and Data Services (Internet). This is not the core of the business, but it can be a key profit generating stream and a major contributor towards the much needed turnaround for Sprint.

Conclusion

Sprint is trading at 97% of its 52 week high, and with the FCC (Federal Communication Commission) continuing to investigate the merger proposal, things have started to look up for Sprint Nextel going forward.

In an attempt to prevent Sprint from acquiring the rest of Clearwire, Dish Network has requested that thr FCC delay the evaluation process of the Sprint-Softbank merger. However, the request was turned down, but the review process will start only after the merger has been investigated by the Justice Department, Homeland Security, and the FBI.

It is of great importance to Sprint that the deal goes through because it needs the cash for upgrading its network and also bringing the Clearwire acquisition deal to its logical conclusion. With Softbank at a risk of getting a Junk Grade from Moody’s Investor Service, it is crucial that investors keep a close eye on the Softbank merger. If the merger successfully goes through we may see a strong rally by Sprint’s stock once the re-structuring is over and the impact of the mergers starts to set in.


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