Sprint (NYSE:S) is one among many companies that we believe is trading at an attractive valuation relative to where we see fundamental value. The stock has come under a lot of pressure since late last year when the company announced plans to sell the hugely-subsidized iPhone even as it continues to invest heavily on building out 4G LTE infrastructure.
The substantial costs associated with these moves forced the company to tap the debt markets twice and add on more debt to its already highly leveraged balance sheet. Sprint also owns over 50% of its 4G network provider, Clearwire, which has been facing a severe cash crunch. Sprint had to use some of its cash on hand to participate in Clearwire’s stock offering in order to provide the struggling carrier with a temporary respite from its liquidity issues. Sprint is hardly in a position to be providing bailouts given its own financial straits and a distant third-place market position behind Verizon (NYSE:VZ) and AT&T (NYSE:T).
With the company’s recent troubles attracting heavy attention, the stock has taken a beating. However, we believe the sell-off has been overdone and the company’s strategy holds long-term promise. We have a $3.75 price estimate for Sprint’s stock, which is more than 50% higher than the market price.
iPhone strategy paying off
Sprint has been incurring heavy annual postpaid subscriber losses for a long time now and its decision to carry the iPhone came as a solution to that problem. However, since Sprint was a tad late in jumping on the iPhone bandwagon, it had to make a huge upfront commitment of nearly $15.5 billion to Apple over a four-year period. This was a massive bet considering that the company has a highly leveraged balance sheet with about $26 billion in debt on its books compared to a market capitalization of only around $7.5 billion.
However, with the company reporting two strong quarters of postpaid net adds on its core Sprint network since the iPhone addition, we believe the bet is working out for Sprint. Sprint added a net 263,000 subscribers to the Sprint platform last quarter, below the previous quarter’s 539,000 but a tad more than net adds posted a year ago. This came even as an increasingly saturated wireless market caused behemoths Verizon and AT&T to add fewer postpaid subscribers this quarter. (see Sprint’s iPhone Bet Is Starting To Pay Off, $3.75 Fair Value)
The iPhone is also bringing in a lot of new subscribers to Sprint. iPhone’s debut quarter at Sprint saw 40% of its sales go to new subscribers. In the next quarter, the iPhone accounted for 660,000 new subscribers to Sprint, which is an improved 44% of its total sales. Sprint’s postpaid ARPU also jumped $3.70 as a result, or 6.6% versus the same period last year, as users of the iPhone are heavy data users as well.
Phasing Out Unsuccessful Networks
While the iPhone’s addition has boosted postpaid adds for the core Sprint platform, the company has been losing subscribers on the other platforms. Along with the core 3G CDMA network Sprint also has a push-to-talk iDEN network that it acquired when it bought Nextel.
As part of its Network Vision project, Sprint is trying to phase out iDen gradually and consolidate its network holdings into one 2G/3G/4G network using a combination of CDMA and EV-DO. This would not only reduce operating expenses substantially, but also allow for better 3G coverage and reduce roaming costs as the spectrum previously used for iDEN would now be available for the CDMA network. The company also plans to roll out 4G LTE, which would eventually replace WiMAX, in order to compete with rivals’ 4G networks. We expect this long-term strategy to help stem postpaid market share losses and also improve margins.
Capex Spike Only In The Near-Term
Sprint’s network costs will increase rapidly as it rolls out its own 4G LTE network by mid-2012 and funds Clearwire’s LTE plans. The company will also be spending significant capital on the Network Vision project. These rising costs led the company to issue capital expenditure guidance of approximately $6 billion for 2012, a jump of more than 100% over last year.  The company has also said that its capex will remain on the higher-end in 2013 as well (about $4 billion), as it completes its Network Vision plan.
After 2013, we estimate a sharp decline in capital expenditures as the company completes its LTE build-out and gradually phases out the iDen network. Sprint’s stock is, however, highly sensitive to its capital expenditures. You can see how the stock price plummets when you tweak the trend-line to increase capital expenditures over the forecast period in the chart below. We think the current market price reflects this sensitivity, as the market likely doesn’t have confidence in management’s guidance.
High Debt Could Derail the Stock
While we believe the market’s response has been somewhat exaggerated, it’s not entirely unwarranted. Liquidity concerns arising from excessive debt on its balance sheet will continue to be a major deterrent to its business, and should this strategy not pay off, Sprint could be in dire straits. (see Sprint Plunges on LTE Expansion Costs, May Tap Capital Markets) On the other hand, if the company is able to grow its postpaid user base by selling the iPhone and execute its Network Vision plan successfully, its long-term prospects look very promising.Notes: