- Sprint has finally reduced subscriber churn and sustained revenue stabilization.
- Maintaining the subscriber base, lowering operating costs by $2 to $2.5 billion and sustaining cell deployment remains critical.
- I believe many of the risks are already embedded into the stock, and I'm initiating coverage with a hold recommendation.
Sprint (NYSE:S) will report earnings on May 3rd 2016, and while the analyst consensus isn’t as optimistic on the company, there’s some potential for value recovery. It’s not exactly easy to completely encapsulate the investment thesis of Sprint, but I believe the recent trends of stabilizing sales and lower subscriber churn are sustainable given maturation of the smartphone market, and lower pricing on postpaid plans when compared to other telecoms.
Furthermore, the company has made significant improvements in its network quality, which is the single most important factor in determining subscriber retention. While Sprint isn’t the fastest network by any stretch of the imagination, the company has made significant improvements in its infrastructure and introduced a new standard referred to as LTE Plus, which has resulted in significant performance improvements.
Quoted from PC Magazine:
There's similar improvement in a lot of major cities, and unlike with Nielsen, different measurements agree here. In Chicago, for instance, RootMetrics says that Sprint's media download speed increased from 13.1Mbps to 22Mbps between May and November. That's "LTE Plus" right there. Speedtest Intelligence agrees: in Chicago, Sprint averaged 10.41Mbps down on LTE in May, and 16.95Mbps in November, a better download speed than T-Mobile (although everyone else crushed it on uploads.)
Sprint has improved its download speeds in a relatively short period of time. The rollout of faster LTE has already occurred in some of the denser regions of the United States. While Sprint doesn’t have the best LTE coverage, it’s noted that the speeds are starting to become more comparable to some of the other networks, which points to better subscriber retention dynamics. At the end of the day, mobile subscribers would ideally prefer lower pricing on reasonable data speeds. I believe Sprint is closer to developing a network that can offer both pricing and functionality, which is dependent given the company’s poor track record historically. I believe raising consumer awareness around data speeds will be difficult to change over the short run.
Sprint isn’t going to directly participate in the 600Mhz spectrum auction, but it’s anticipated that Sprint’s parent company (Soft Bank owns 80% of Sprint) will set up a foreign holding company that will bid at the auction, which translates to a leaseback or spectrum swap to Sprint itself. The low band spectrum is important because it’s the last major spectrum auction anticipated over the next 10-years. Given low band spectrum has higher penetration, and requires fewer mobile base station, it’s more CapEx efficient (over the short run). Furthermore, Sprint has made efforts to shore up cash through a sale of mobile base station equipment worth $3 billion and will leaseback those same base stations from those holding companies. The extra cash infusion will be used for further capacity build up, as Sprint itself isn’t directly participating in the spectrum auction.
Furthermore, it will take three years for broadcast stations to transition off of the spectrum, so mobile carriers can use those airwaves. So, even if Sprint misses out on the auction, it doesn’t translate into an immediate competitive disadvantage. It will take years before the other telecoms are able to advertise faster speeds as a result of the low band spectrum. Furthermore, Sprint still has plenty of higher frequency spectrum, which requires higher investment but has higher data throughput. It all balances out in other words, so Sprint’s position is heavily dependent on whether the company can gain subscriber share and can sustain its base station roll out.
Including the $3 billion in leasebacks plus the $5 billion in projected CAPEX, Sprint will invest $8 billion into its network footprint this year. Verizon is expected to spend $17.7 billion in Capex for FY’16, so the differences in accumulated network infrastructure will remain massive. Despite the massive differences in investment, Sprint has accumulated customers by offering unlimited data plans at much lower pricing (some carriers do not offer this feature).
Sprint can offer unlimited data due to the 2.5 GHz spectrum and densification of cell sites using micro cells. The company is improving its backhaul by going wireless and is also exploring network function virtualization. Given Sprint’s lagging infrastructure, the company will need to deploy new technologies to reduce the cost footprint around its base station deployment. Furthermore, Sprint moved its guidance range higher on adjusted EBITDA from $6.8 billion - $7.1 billion to $7.7 billion to $8 billion, which implies an incremental $800 million in expense reductions on an adjusted basis from prior guidance. Sprint also mentioned that it will return to operating profitability to the tune of $100 million to $300 million.
Reducing cost at the operating level will be difficult while also sustaining flat or low single digit revenue growth. As such, many on the sell side remain skeptical and have modeled more conservatively. The company mentioned that it’s confident of reducing cost by $2 to $2.5 billion by the end of the year, according to Deutsche Bank’s telecom conference.
Going into the quarter, the current analyst consensus estimate is for EPS is (0.43) and $8.69 billion in revenue. I believe these figures aren’t too aggressive, but there are a lot of risks embedded into the stock. Furthermore, the company continues to burn cash and requires frequent infusions in the form of debt offerings and third-party investment thus resulting in dilutive events to the pre-existing shareholder base.
I’m initiating my coverage on Sprint with a hold rating. While, I don’t have an exact price target in mind, I believe many of the risks are already priced into the company. Meanwhile, Sprint is uniquely positioned to deploy network technologies more efficiently given technological changes and adoption of network specific technologies. Therefore, recapturing costs seems like a matter of time.
With speeds improving in many markets, I believe subscriber churn and postpaid additions will eventually level out thus driving revenue stabilization. However, expectations on sales should be tempered until Q4’16 where a lot of smartphone contracts are up for renewal. As such, the near-term focus is on cost reductions whereas back half results will depend heavily on subscriber gains.