Sprint (NYSE:S) announced a mixed set of Q1 results in its earnings report July 25th. The company said that its revenues grew more than 6% over the same period last year and that it added a net 442,000 postpaid subscribers to its core Sprint platform (excluding Nextel losses) banking on another quarter of healthy iPhone sales.  However, that did not stop its net losses from mounting as it accelerated the depreciation of its outdated Nextel network and wrote down the value of its Clearwire investment. Net losses for the quarter came in at $1.4 billion, up from $847 million incurred a year ago.
What was however noteworthy was that despite the iPhone subsidies and the heavy capital expenses Sprint is incurring on the execution of its Network Vision strategy, it was able to generate $209 million of free cash flow during the quarter. Sprint’s OIBDA margins, adjusted for non-cash items such as D&A and iDEN lease exit costs, improved by 277 basis points sequentially and 69 basis points over the same period last year. The company also increased its guidance for the full year adjusted OIBDA “to a range of $4.5 billion to $4.6 billion”.
Improving visibility of the benefits of the iPhone as well the Network Vision plan helped move the stock up by over 2o% post the earnings call. However, we believe that risks surrounding its high debt levels and burgeoning capital expenses still exist, which could have an adverse impact on cash flows in the coming quarters. The stock price is currently 10% over our revised price estimate of $4 for Sprint.
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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 already has a highly leveraged balance sheet with about $26 billion in debt on its books compared to a market capitalization of only around $12 billion.
That bet seems to be paying off now that the company has had three strong quarters of postpaid net adds (excluding Nextel losses) on its core Sprint network. Sprint added a net 442,000 subscribers to the Sprint platform this quarter, almost double as many as it did in the year-ago quarter and 70% higher sequentially. While this figure was boosted by the number of iDen subscribers Sprint was able to migrate to its core CDMA network, it also came in a highly saturated market that is causing behemoths Verizon and AT&T to add fewer postpaid subscribers this year.
The iPhone’s role in the impressive postpaid net adds that Sprint is posting every quarter becomes more evident in the number of new subscribers it is bringing to Sprint. This quarter, the iPhone accounted for about 600,000 new subscribers to Sprint, 40% of its total iPhone sales. Sprint also managed to increase its market share of iPhone sales, keeping its iPhone sales flat in a quarter both Verizon and AT&T saw sequential declines of 14% and 16% respectively.
What is also impressive about Sprint’s postpaid net adds is that it has been able to add as many despite not selling the iPad, which has brought in quite a number of postpaid subscribers to both Verizon and AT&T. AT&T, for example, saw more than half of its about 330k postpaid net adds come from tablets. While the iPad is cheaper for carriers considering that it carries no subsidies, an average tablet user brings in lower average revenues as compared to a smartphone user.
Increasing number of iPhone postpaid subscribers also helped push its postpaid ARPUs up by more than $4 to $61. The high number of iDEN subscribers that shifted to Sprint’s core CDMA platform (Sprint re-captured almost 60% of iDEN losses, up from a historical 25% recapture rate) will help push the overall postpaid ARPUs further up in the coming quarters since iDEN postpaid ARPUs are lower than Sprint platform ARPUs. Postpaid ARPUs will also continue to be positively impacted by an increasing smartphone penetration and the $10 premium add-on charge that Sprint had started levying on all smartphone activations in 2011.
CapEx headwinds could limit cash flow
Meanwhile, the risks from its highly leveraged balance sheet and an ever-growing capital spend due to the ongoing implementation of its Network Vision strategy still persist. So far, it has spent only about $2 billion of the $6 billion it plans to spend on LTE infrastructure, 3G upgrades and iDEN shutdown this year. The remaining $4 billion spend could negatively impact free cash flow generation in the coming quarters. Sprint is highly sensitive to capital expenditures, as can be checked by moving the trend line in the forecast chart below and following the corresponding impact on its price estimate.
However, while the Network Vision plan is very expensive, a successful implementation of the strategy will reduce the operating expenses substantially by eliminating the duplicate fixed costs of maintaining different networks. It will also allow for better 3G/4G coverage and reduce roaming costs as the spectrum previously used for iDEN would be utilized for the CDMA/LTE network. (see Sprint To Build LTE Over iDEN’s Grave) Rolling out an LTE network will also help it improve its service gross margins, since it is a more efficient network to manage than the existing 3G networks.
As LTE adoption rates rise and the iPhone brings in highly lucrative postpaid subscribers, Sprint will also see its data ARPU levels rise in concert. Sprint’s unlimited LTE plans will help it maintain its niche and differentiate itself from rivals’ tiered data plans. Unlimited plans will likely be more valuable for LTE than they were for 3G since LTE is a higher-speed technology and will cause subscribers to easily overshoot their monthly quota for tiered plans. (see Sprint Promotes Unlimited Plans As Verizon, AT&T Move To Shared-Data Plans)Notes:
- Sprint Nextel’s CEO Discusses Q2 2012 Results – Earnings Call Transcript, July 25th, 2012 [↩]