Why This Telecom Always Comes in Third

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

I know there are investors that believe that Sprint (NYSE: S) is a completely different company with Softbank's investment. However, the company's recent results make me question what Softbank's management thought they were buying. It would be one thing if Sprint were growing and making progress, but by nearly every metric this company turns out to be at best the third best wireless carrier.

Positive Network Results Hurt if You Aren't One of the Big Boys:

In the wireless industry, there is something known as the positive network effect that the largest carriers benefit from. In plain English, the largest carriers gain subscribers simply because there are more people already using their services. You can see this play out in the results of AT&T (NYSE: T) and Verizon (NYSE: VZ). These two largest carriers added over 670,000, and 1.8 million net additional wireless subscribers in the last three months. By comparison, smaller carriers like Sprint struggle to maintain their existing subscribers, and with the transition from the Nextel network, the numbers aren't pretty. While Sprint did report revenue up 5%, the company's EPS loss increased from $0.10 last year to $0.26 this year. I'm sure it makes management feel better to report numbers for the Sprint platform versus the Nextel platform. Unfortunately for shareholders, there are increasingly less customers sticking with Sprint.

Subscribers Are Leaving No Matter How You Report the Numbers:

In the recent quarter, Sprint reported a total of about 56 million customers using their services. However, the company's results are a bit confusing as Sprint has a larger than normal amount of prepaid subscribers relative to their two larger competitors. In fact, Sprint is actually one of the largest prepaid wireless companies, with 15.4 million subscribers versus the roughly 9 million subscribers at MetroPCS (NYSE: TMUS). For those who are not aware of the statistic, this might come as a surprise. MetroPCS is more well-known as a prepaid company, and many people probably assume that Sprint primarily attracts postpaid subscribers. In a way, it's a good thing that Sprint does attract as many prepaid subscribers, because this is where they are actually growing their customer base. In fact, on a year-over-year basis, Sprint added a net of 19,000 prepaid subscribers. When it comes to postpaid subscribers, the company ended with 32.1 million customers, but this was a decline versus last quarter. The confusion is, Sprint reports adding 410,000 net postpaid subscribers on the Sprint network, while reporting 866,000 in losses on the Nextel network. Here is the problem, losing 866,000 subscribers to gain 410,000 subscribers still means you lost over 450,000 customers during the quarter. With the two largest players adding more subscribers, and Sprint reporting a net loss of subscribers, the gap between the two biggest players and their next rival is getting even bigger.

Unfortunately for Sprint investors, another area where the company comes in third is in their wireless churn. While Sprint reported its 1.88% churn rate as being better than last year, this still was higher than AT&T at 1.08%, or Verizon at 0.91%. In fact, this is where Sprint's attraction of prepaid subscribers hurts the company. MetroPCS also attracts more prepaid subscribers, and that company's churn rate was 3.7% in their most recent quarter. As long as Sprint continues to attract prepaid subscribers, it is simply easier for these customers to leave than it is for subscribers who are under contract.

Sprint's Balance Sheet May Get Better, But Cash Flow Is An Issue:

I know many investors in Sprint have pinned their hopes on Softbank's investment shoring up the balance sheet. Though the future might be different, Sprint's debt to equity ratio was 1.77 last year, this year that same ratio sits at 2.47. One thing Softbank's investment won't cure is Sprint's troubling cash flow issues. In the current quarter, Sprint reported adjusted operating cash flow that was down 23.5% versus last year. In fact, the company's adjusted free cash flow was actually negative $815 million. Even MetroPCS managed to generate almost $300 million in free cash flow in the last several months. You have to wonder why Sprint with five times more subscribers is unable to turn in better results. The fact that both AT&T and Verizon reported free cash flow of over $13 billion over the last nine months makes this comparison even more difficult.

Conclusion:

No matter where I look there just aren't a lot of positives for Sprint investors to hold onto. Their two top competitors both pay significant dividends, which is something that Sprint cannot claim. In fact, each of the company's major competitors is expected to grow faster than Sprint over the next five years. In addition, their major competitors all generate positive free cash flow, and are expected to report positive earnings next year. Whether investors choose double the growth rate at MetroPCS, or good growth and excellent income from AT&T or Verizon, there isn't a great argument for the expected negative earnings at Sprint. Although the company might grow faster than analysts expect, negative free cash flow, negative earnings, and fleeing subscribers, don't seem to be the recipe for great results in the future.


MHenage owns shares of Verizon Communications. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend AT&T.; Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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