Sprint (NYSE:S) is scheduled to announce its Q4 2013 results on February 11th. The third largest wireless carrier in the U.S. is facing intense competition for new subscribers, with rival T-Mobile stepping up its ‘Uncarrier’ promotions and 4G LTE buildout efforts to post impressive net add gains in the last few quarters. Sprint has also been lagging bigger rivals Verizon (NYSE:VZ) and AT&T (NYSE:T) in LTE coverage, which is proving key to retaining as well as adding new subscribers in a saturated market. Last quarter, the carrier posted a net loss of 360,000 postpaid subscribers, excluding acquisitions from Clearwire and US Cellular, as compared to a net gain of 410,000 posted a year ago. While we expect Sprint to benefit from strong smartphone sales during the holiday season to continue to post a sustained increase in its ARPU levels, the carrier’s postpaid net adds in Q4 will be a key metric to watch out for on this earnings call. We will also be following the impact of smartphone subsidies on Sprint’s margins, which should be offset to an extent by the cost savings that the carrier is realizing from the shutdown of its iDEN network and the ongoing Network Vision initiatives.
The carrier has seen its shares go through a very volatile period of late, on the back of rumors that it is lining up a potential acquisition bid for T-Mobile in the coming months. While such a deal could help Sprint compete better with Verizon and AT&T, it faces regulatory issues as well as significant risks associated with integrating two huge complex networks (see Sprint’s Potential Bid For T-Mobile Could Make For A Risky Merger). Sprint’s shares rallied almost 60% on the rumors in the last two months of 2013 but have since shed most of those gains this year. Our $7 price estimate for Sprint is about 10% below the current market price.
Sprint Looks To Make Up For LTE Lag With Spark
Sprint has so far looked to differentiate itself from rivals with unlimited data plans, which have helped it maintain its niche in an industry that is rapidly moving toward tiered data plans. While heavyweights Verizon and AT&T long ago stopped offering unlimited plans and are instead promoting new tiered plans that can be shared across multiple devices, Sprint has steadfastly hitched itself to unlimited plans, even going so far as to offer a lifetime guarantee on these plans. However, this ploy hasn’t worked particularly well in recent quarters, as the carrier suffered sustainued postpaid subscriber losses due to heightened competition and deficiencies in its LTE coverage.
Sprint had managed to dodge the bullet for a while by banking on an accelerated iDEN shutdown to add new postpaid subscribers to its core CDMA platform. In the first two quarters of 2013, Sprint added a little over 200,000 postpaid CDMA subscribers despite recapturing almost three times as many from its iDEN network. Sprint’s poor CDMA performance in Q3 was 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. That the trend will have continued in Q4 as well can be gauged from the fact that T-Mobile, the worst performing of the top four in the fourth quarter of 2012, added 869,000 net postpaid subscribers last quarter compared to a loss of 515,000 in the year-ago quarter. T-Mobile announced its porting ratios last month, which showed that the most affected by its resurgence was Sprint which lost 3 subscribers to T-Mobile for ever one that it gained.
To be fair, the iDEN migration has historically benefited rivals in the past as well, but the fact that Sprint’s LTE coverage is lagging rivals could hinder its wireless growth in the near term. While Verizon has completed its initial LTE build-out and covers over 300 million people currently, AT&T has an LTE coverage of about 280 million PoPs. In comparison, Sprint’s LTE coverage is estimated to have reached only 200 million Americans by the end of 2013. Even T-Mobile, which started its LTE build-out much later than Sprint, has raced ahead with 209 million PoPs under coverage currently and further expansion plans afoot.
It is in this context that the importance of Sprint’s Spark strategy comes to the fore. By helping Sprint catch up in LTE coverage and potentially lead the industry in terms of data capacity and speeds, Spark will finally give the carrier a compelling advantage to differentiate on service rather than pricing. This is important for the long-term ARPU growth of the company, which is currently limited by its over reliance on unlimited plans. With data demand surging, offering subscribers access to unlimited data could prevent Sprint from capitalizing on the future growth in data usage as LTE speeds become ubiquitous. By differentiating on data speed and capacity, Sprint could come up with innovative speed-based tiers at premium pricing to mitigate the long-term impact of its unlimited data plans. We also expect a successful implementation of Spark to help Sprint’s subscriber trends improve, as reflected in the chart below, as the carrier launches its enhanced LTE network in new cities and aggressively markets its speed advantage over rivals in the later part of the year. But Sprint’s lagging LTE coverage and the slow pace of TD-LTE deployment mean that the carrier will continue to face competitive pressures in the near term (see Sprint’s Spark Program Will Have Long-Term Benefits, Doesn’t Mitigate Near-Term Risks).
ARPU and Margin Increase
However, the carrier is seeing its ARPU levels grow strongly on the back of strong adoption of smartphones such as the iPhone. The carrier has done a fine job with the iPhone, using it effectively to bring aboard high quality postpaid subscribers from rival platforms. Although Sprint’s iPhone sales of 1.4 million in Q3 were down 7% y-o-y, almost 40% of these sales went to new customers. The introduction of the iPhone at T-Mobile was probably responsible for Sprint’s 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 in Q3 up by about 2% y-o-y to a record $64.20.
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 last year was $8 billion, almost double what it spent in 2012. With the added costs of Spark, it will be interesting to see the CapEx guidance that Sprint gives for 2014. While the network modernization plan is proving to be expensive, it is also helping reduce operating expenses substantially by eliminating the duplicate fixed costs of maintaining different networks. It is allowing for better 3G/4G coverage and reducing roaming costs as the spectrum previously used for iDEN is increasingly utilized for the CDMA/LTE network. Rolling out an LTE network is helping it improve its service gross margins as well, since it is a much more efficient network to manage than the existing 3G networks. Sprint’s wireless EBITDA margins in the first three quarters of 2013 increased by 2 percentage points over the same period the previous year.