Sprint Faces Tough Few Quarters Ahead Before It Can Leverage Network Vision

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Sprint (NYSE:S) announced a mixed set of Q2 results October 30th, as a sustained increase in data demand helped wireless service revenues grow y-o-y for the 13th straight quarter despite rising subscriber losses. Excluding acquisitions form Clearwire and US Cellular, the carrier reported a net loss of 360,000 postpaid subscribers in Q3 as compared to a net gain of 410,000 posted a year ago. The shutdown of the iDEN network last quarter prevented the carrier from bolstering its core CDMA net adds with iDEN recaptures. However, this impact was more than offset by a sustained increase in Sprint’s ARPU levels, driven by increasing smartphone penetration and an additional insurance fee that some of its iPhone customers started paying this year. Going forward, with the iDEN network shut down and the U.S. wireless market nearing saturation, Sprint could find it even tougher to find new subscribers in the coming quarters given its lagging 4G LTE coverage compared to rivals Verizon (NYSE:VZ) and AT&T (NYSE:T).

To mitigate this impact, Sprint is splurging on its Network Vision strategy to increase LTE coverage to about 200 million POPs by the end of the year. In the first three quarters this year, Sprint’s wireless capital expenditures have increased by about 65% over the same period last year. The carrier has also used its recent infusion of cash from Softbank to buy out Clearwire and use its huge swath of 2.5 GHz spectrum to bolster LTE capacity in densely populated areas. Using this spectrum, Sprint plans to offer up to ten times faster speeds than the current LTE network. However, acquiring Clearwire’s loss-making business had a dilutive impact on margins. This was, however, more than offset by the cost savings that Sprint realized from not having to run two disparate networks – iDEN and CDMA – concurrently for the first time this quarter. Sprint’s wireless EBITDA margins expanded by about 120 basis points over the same period last year to 16.5%. Our revised $6.50 price estimate for Sprint is about in line with the current market price.

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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. Until Q2, Sprint had managed to dodge the bullet by banking on an accelerated iDEN shutdown to add new postpaid subscribers to its core CDMA platform. In the first two quarters this year, Sprint had added a little over 200,000 postpaid CDMA subscribers despite recapturing almost three times as many from the iDEN network. Sprint’s poor Q3 performance is actually a continuation of the same trend that could be the new normal without the iDEN network, which had been a steady supply of CDMA subscribers in the past. To be fair, even Verizon and AT&T are likely to have historically benefited from the iDEN migration; so the issue won’t be Sprint’s alone. However, the fact that Sprint’s LTE coverage far lags wireless leaders Verizon and AT&T could hamper its wireless growth in the coming quarters.

It is in this context 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 Q3 were down 7% y-o-y, almost 40% of these sales went to new Sprint customers. The introduction of the iPhone at T-Mobile was probably responsible for the y-o-y iPhone sales decline – another sign of the increasingly competitive environment that Sprint will have to negotiate until its Network Vision Plan is substantially complete next year. The growing number of iPhone postpaid subscribers helped push Sprint’s core platform postpaid ARPUs up by about 2% y-o-y to a record $64.20. Going forward, the increasing adoption of Sprint’s recently launched One Up no-contract plans – which have lower service fees than its contract plans – could negatively impact ARPU levels, offset to an extent by increasing smartphone penetration.

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. Its CapEx target for this year is $8 billion, almost double what it spent in 2012. 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 will 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. At the same time, using Clearwire’s 2.5 GHz spectrum will further bolster Sprint’s LTE network, allowing it to compete more effectively with rivals. The carrier said that it plans to cover about 100 million POPs with the faster LTE network by the end of 2014.

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 make it easier for subscribers to 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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