Sprint (NYSE:S) announced a mixed set of Q3 results in its earnings report October 25th. The company said that its revenues grew more than 5% over the same period last year and that it added a net 410,000 postpaid subscribers to its core Sprint platform (excluding Nextel losses) banking on another quarter of healthy iPhone sales. Subscribers however continued to flee the Nextel iDEN network as Sprint accelerated its shutdown but the company managed to absorb a majority of them back into the core Sprint network at almost double the historical recapture rate. That, however, did not stop its net losses from mounting as it accelerated the depreciation of its outdated Nextel network and incurred other one-time expenses related to the shutdown. Net losses for the quarter came in at $767 million, up from $301 million incurred a year ago.
Despite incurring huge iPhone subsidies, Sprint managed to generate $628 million of cash from its operations but burned through all of it and more, as it entered the “investment phase” associated with its Network Vision Plans and LTE layout. Sprint’s capital expenditures almost doubled over the same period last year to about $1.5 billion, and the company now expects to be cash flow-negative for the next several quarters. However, with the iPhone doing well and Network Vision leading to cost savings, the company now sees itself exceeding the OIBDA forecast for the year on the high end. We maintain our price estimate of $5.30 for Sprint’s stock, about in line with 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 over $26 billion in debt (including operating leases) on its books compared to a market capitalization of only around $16 billion.
That bet seems to be paying off now that the company has had a full year of strong postpaid net adds (excluding Nextel losses) on its core Sprint network. Sprint added a net 410,000 postpaid subscribers to the Sprint platform this quarter, almost 55% higher than the year-ago quarter. The iPhone’s role in the impressive postpaid net adds that Sprint is posting every quarter is 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. For all the four quarters that Sprint has had the iPhone, at least 40% of iPhone activations each quarter have been new customers.
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 almost two-third of its postpaid net adds came from tablets in the first half of 2012. However, Sprint announced recently that it will be carrying the iPad mini as well as the fourth-generation iPad announced recently, which should help bolster net add numbers in the coming quarters. This may however be offset by the dwindling base of Nextel subscribers who have also been a big source for the Sprint platform net adds in recent quarters.
Increasing number of iPhone postpaid subscribers helped push Sprint’s overall postpaid ARPUs up by more than 6% y-o-y to over $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 improve the overall postpaid ARPUs further 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 less than 60% of about $6 billion it plans to spend on LTE infrastructure, 3G upgrades and iDEN shutdown this year. The remaining $2.5 billion spend could severely impact free cash flow generation next quarter. 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) Almost 9,600 iDEN cell sites were taken off air in Q3 and the initial signs of cost savings could be seen as 3G roaming expenses declined for the first time in close to three years by about 3% y-o-y. 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)