Sprint Looks To A New Future With Softbank But Subscriber Growth A Concern

Sprint (NYSE:S) announced a mixed set of Q2 results July 30th, as wireless service revenues rose to an all-time high of $7.2 billion on increased data demand but subscriber losses mounted as the legacy iDEN network was finally shut down. The third largest wireless carrier in the U.S. completed the iDEN shutdown towards the end of the quarter, losing all the remaining 1.06 million subscribers in the process but managing to recapture about 34% of them on its core CDMA network.

The iDEN recaptures as well as the acquisition of subscribers from the U.S. Cellular deal helped Sprint add about 194,000 postpaid subscribers to its core CDMA platform. Excluding these non-recurring adds, Sprint would have reported a net loss of upwards of 200,000 postpaid CDMA subscribers in Q2. Going forward, with the iDEN network shut down and the U.S. wireless market nearing saturation, Sprint will find it even tougher to find new subscribers given its lagging 4G LTE coverage as compared to rivals Verizon (NYSE:VZ) and AT&T (NYSE:T).

It is to mitigate this impact that Sprint is splurging on its Network Vision strategy to increase LTE coverage to about 200 million POPs by the end of the year. As a result, Sprint’s wireless capital expenditures increased by about 70% y-o-y to over $1.7 billion during the quarter. The carrier has also used its recent infusion of cash from Softbank to buy out Clearwire and use its huge swathe of 2.5 GHz spectrum to bolster LTE capacity in densely populated areas. Acquiring Clearwire’s loss-making business will however depress Sprint’s margins and cause its debt load to burgeon. However, we expect the impact to be more than offset by the cost-savings Sprint will realize from having a wider coverage as well as not having to run two disparate networks, iDEN and CDMA, at the same time. Our revised $6.35 price estimate for Sprint is about in line with the market price.

See our complete analysis for Sprint

Saturated wireless market and LTE lag to blame

The U.S. wireless market is getting increasingly saturated with the number of wireless connections having exceeded the population in mid-2011. While Sprint has so far managed to dodge the bullet by banking on an accelerated iDEN shutdown to add new postpaid subscribers to its core CDMA platform, the going might get a lot tougher in the next few quarters. In the last two quarters combined, Sprint has added a little over 200,000 postpaid CDMA subscribers despite recapturing almost thrice as many from the iDEN network. Now, without the iDEN network, which has seen a steady supply of CDMA subscribers in the past, it will be challenging for Sprint to find new subscribers. To be completely fair, even Verizon and AT&T are likely to have benefited from the iDEN migration in the past several quarters; so the issue won’t be Sprint’s alone. However, the fact that Sprint’s LTE coverage far lags the wireless leaders, Verizon and AT&T, could hamper its wireless growth in the coming quarters.

It is in this light that the importance of the iPhone comes to light. The carrier seems to have done a fine job with the iPhone, using it effectively to bring aboard high quality postpaid subscribers from rival platforms. Although iPhone sales of 1.4 million in Q2 was down 7% y-o-y, almost 41% of these sales went to new Sprint customers. The introduction of the iPhone at T-mobile may have been responsible for the y-o-y iPhone sales decline, but Sprint assuaged concerns by saying that it was well ahead of its volume commitment targets. The growing number of iPhone postpaid subscribers helped push Sprint’s overall postpaid ARPUs up by about 1% y-o-y to a record $64.20. Driven by increasing smartphone penetration, we expect Sprint’s postpaid ARPUs to continue to grow in the coming quarters, but at slower rates than last year.

High CapEx justified in the long run

In order to support the surging data demand and to position itself competitively against rivals, Sprint is aggressively investing in network upgrades and LTE deployment as part of its Network Vision initiative. However, while Network Vision is proving to be expensive, a successful implementation of the strategy will reduce operating expenses substantially by eliminating 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 help it improve its service gross margins as well, since it is a much more efficient network to manage than the existing 3G networks. The carrier said that it is on track to cover about 200 million POPs with its LTE network by the end of 2013.

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, which it has recently started promoting with a lifetime guarantee, 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)

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