Sprint Earnings: Subscriber Losses Continue But Network Overhaul Could Turn Things Around

Sprint (NYSE:S) announced a mixed set of fiscal first quarter results on Wednesday, July 30, losing postpaid subscribers due to service disruptions owing to its ongoing network overhaul (“Network Vision”) and heightened competition in the industry. The third largest wireless carrier in the U.S. lost 181,000 net postpaid subscribers during the quarter, as compared to a net gain of 194,000 posted in the same period last year. The figure included tablet net adds of 535,000, which means that Sprint’s loss of the more lucrative handset subscribers was even worse. On the positive side, the company’s margins expanded to the highest level in almost six years on effective subsidy controls and network savings.  ((Sprint Earnings Call Transcript, Seeking Alpha, July 30 2014))

The carrier is facing intense competition for new subscribers, with rival T-Mobile stepping up its “Uncarrier” promotions, AT&T (NYSE:T) responding aggressively with its “Next” plans and market leader Verizon (NYSE:VZ) banking on its superior network quality and “More Everything” offerings. Sprint has also been lagging rivals Verizon and AT&T in LTE coverage and quality, which is proving key to retaining and adding new subscribers in a saturated market. However, management stated that most of the company’s network upgrade has been completed and its 4G LTE network now covers about 254 million people in 488 cities across the country. We expect this to help the carrier reduce its high churn levels and improve net monthly additions going forward. Sprint expects to get back to positive net user adds by the end of this year. ^[1]

The LTE build-out, coupled with the iDEN shutdown, helped the carrier improve network efficiency, which together with a strong response for its “Framily” installment plans helped Sprint’s adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) grow by 30% year-over-year (y-o-y) to $1.83 billion and EBITDA margins by 640 basis points over the same period last year. On account of consistent margin improvements, the carrier reiterated its EBITDA guidance for calender year 2014 to range between $6.7-6.9 billion, which it increased from $6.5-6.7 billion in the previous quarter. We expect the adoption of Sprint’s installment plans to grow going forward, which should boost margins but is likely to put pressure on service ARPU (average revenue per user) as the tablet mix increases and subscribers shift to discounted plans. We have a $8.50 price estimate for Sprint, implying a premium of about 10% over the current market price.

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Upgraded Network Likely To Help Improve Churn

With the wireless market becoming increasingly saturated, carriers have become aggressive with their pricing strategies in order to gain market share. T-Mobile started the trend with its “Uncarrier” initiatives, stealing market share from rivals in the process. AT&T’s aggressive response to T-Mobile, when it pushed its “Next” installment plans and discounted the service prices of its Mobile Share plans, further intensified the competition. Although reluctant to get into a price war initially, Verizon raised it up a notch with its recent “More Everything” and “Edge” plan offerings. The promotional activities and discount offerings seem to have worked well for AT&T and Verizon, with the carriers reporting postpaid subscriber gains of 1.07 and 1.45 million, respectively, in the three month period ending June 30 this year.

The adverse impact of rising competition on Sprint can be gauged from the fact that it reported a net loss of 181,000 postpaid and 542,000 prepaid subscribers in the last quarter. Although the loss of prepaid subscribers intensified in this quarter compared to the previous quarter (364,000), the carrier reported an improvement in net postpaid subscriber losses. This was also reflected in the carrier’s overall retail churn rate, which improved by 9 basis points to 2.09% in the postpaid segment but increased by 15 basis points to 4.50% in the prepaid market. We expect Sprint to further improve its postpaid churn rate going forward owing to its upgraded network.

CapEx Guidance Reduced On Efficient Capital Spending

Sprint’s LTE coverage – another important consideration for subscribers and a concern over the last couple of years – reached 254 million PoPs (points of presence) by the end of June, meeting the company’s target of 250 million PoPs. With the carrier’s “Spark” plans expected to pick up speed after the LTE rollout, we expect Sprint to become a lot more competitive towards in the latter half of 2014 and beyond. The Spark strategy will help it make use of Clearwire’s 2.5 GHz spectrum to add data capacity and potentially push 4G speeds to more than five times what is currently prevalent in the industry. The company stated in its earnings call that its median data downlink speeds increased about 20 times in the last nine months to over 30 Mbps. This result was obtained in a study conducted by RootMetrics for O’Hare International Airport (ORD) in Chicago. ^[2]

Considering that the implementation of Spark was likely to require significant capital expenses, Sprint maintained its elevated capital expenditure forecast of $8 billion for calender year 2014 in the previous quarter. However, since the Network Vision rollout has been substantially completed by now, and the company is experiencing high levels of efficiency in its capital spending, it has reduced its 2014 CapEx forecast by 12.5% to $7 billion.

Margins vs. ARPU

The network modernization plan is helping Sprint in reducing its 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 Sprint improve its service margins as well, since it is a much more efficient network to manage than the existing 3G networks. Sprint’s adjusted wireless EBITDA margins increased by 770 basis points (7.7 percentage points) y-o-y to 25.3% in the quarter ending June 30 this year.

Wireless margins were also helped by the increasing adoption of Sprint’s “Framily” plans, which drove device sales through its Easy Pay installment plans. This is because the carrier was able to recognize a greater portion of the device’s upfront cost as revenues when subscribers financed their devices through installment plans. The accounting change helped the carrier realize significant margin gains, as Easy Pay accounted for 28% of all device sales during the quarter.

However, increasing penetration of “Framily” plans will pressure ARPU levels, since the separation of the wireless and device bill has led to lower service plan prices for subscribers. In the last quarter, the carrier’s postpaid ARPU declined by $2.13 or over 3% y-o-y to $62.07, driven by the gradual user migration to “Framily” plans and higher mix of tablets in the devices base. Considering that the present trend is likely to continue in the near term, Sprint’s higher margins are likely to come at the expense of its ARPU.

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1. Press Release, Sprint, July 30 2014 [↩]
2. Q1 2014 Presentation (Page 18), Sprint, July 30 2014 [↩]