Sprint’s Turnaround Gains Momentum, But It Isn’t Out Of The Woods Yet

Sprint (NYSE:S) posted a stronger than expected set of Q1 FY’15 earnings, indicating that its turnaround plan is headed in the right direction. The carrier is executing well on its primary goal of stabilizing its subscriber base, as postpaid net losses and churn numbers improved significantly. ^[1] However, the carrier isn’t out of the woods just yet, in our view. Its ARPU and margins remain under pressure, on account of aggressive pricing plans and competition from larger and better-capitalized rivals. Moreover, its high debt load and weakening cash position continue to be a cause for concern, given that it is looking to invest further in boosting its network capacity and coverage. However, Sprint’s majority shareholder Softbank reiterated that it remains committed to the company and its turnaround plan, which should be reassuring for investors given Softbank’s relatively deep pockets. ((Sprint (S) R. Marcelo Claure on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, August 2015)) While we remain bullish on Sprint, we have lowered our price estimate to just below $5 per share to account for its weaker cash position and our slightly higher capex forecasts in the outer years. This implies a premium of over 30% to the current market price. In this note, we take a look at some of the key developments in the earnings release and how they could impact the company’s stock price going forward.

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Aiming For Revenue Growth By Stabilizing Subscriber Base

The first and most important step of Sprint’s turnaround plan is to stem subscriber losses, since this is the only sure way to remain competitive in a saturated wireless market. The carrier appears to have done well in this regard, banking on its competitive pricing options and a gradual improvement in network quality. Sprint platform postpaid subscriber losses narrowed to 12,000 for the quarter, compared to a loss of about 620,000 in the year-ago quarter. Moreover, the carrier posted postpaid phone net adds through the months of May, June and July – indicating that the metric could finally turn positive in the current quarter. Notably, the Sprint platform postpaid churn rate improved 0.49% y-o-y to 1.56%. While all major U.S. carriers have been posting improved churn levels in recent quarters – driven by potentially stricter credit standards, a greater number of devices attached to plan accounts and the proliferation of similar plan options across carriers – Sprint’s progress is particularly noteworthy, given that it was bleeding subscribers just a year ago. The metric is important for the carrier since the cost of retaining existing subscribers is significantly lower than the cost of acquiring new subscribers. While Sprint’s total subscriber base grew by 5.7% year-over-year to 57.67 million in total, it fell short of T-Mobile’s 58.9 million, and the carrier slipped to fourth place in the U.S. wireless market.

Network Improvements Could Pay Dividends

Although Sprint’s aggressive promotional pricing plans have helped it post overall net additions, they have impacted the carrier’s revenues. Sprint’s average billings per postpaid user declined by 3% y-o-y to $61.67. This is something Sprint can’t afford to maintain, considering its huge debt load (net debt of over $28 billion) and large capex plans (cash capex $5.0 billion for this year). ^[2] It’s likely that the company will eventually switch gears from merely stabilizing its customer base to focusing on improving revenues from existing customers.

Network quality is perhaps the biggest differentiator in the wireless business, and it remains the biggest determinant of carriers’ pricing power and ARPUs. Sprint has been making some progress in this regard. For example, the carrier has indicated that average download speed across its network rose 133% year-over-year while its LTE latency is now the lowest among the big 4 carriers. Now, Sprint intends to undertake a large network improvement project that will entail new macro sites and tens of thousands of new small cells, in a move that could help to further improve capacity as well as coverage. The carrier is also looking to upgrade of all of its existing sites to support all three of its spectrum bands – 850 MHz, 1900 MHz and 2.5 GHz. Sprint’s CEO believes the company’s network performance will match or exceed Verizon and AT&T within two years. We believe that a successful (and capital efficient) network overhaul could pay rich dividends for Sprint in terms of higher ARPUs. If the carrier is able to increase its data ARPU to about $38 by the end of our forecast period (CY2022), versus our current estimate of $32, this could result in an upside of roughly 40% over our current price estimate.

Earnings Highlights

• Quarterly net loss of $20 million or $0.01/share, compared to a profit of $23 million or $0.01/share a year ago.
• Revenues down 8.7% y-o-y to $8.03 billion.
• Cash and cash equivalents fell to $2.06 billion from $4.010 billion last quarter.
• Sprint platform net adds of 675,000 versus net losses of 220,000 in the prior year quarter
• Consolidated Adjusted EBITDA guidance for the year raised to between $7.2 billion to $7.6 billion from a previous estimate of $6.5 billion – $6.9 billion.

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1. Sprint Earnings Press Release [↩]
2. Sprint Earnings Call Presentation [↩]