Who Says Sprint Nextel Needs to Sell?
Back in early September, London’s Daily Telegraph published an article that indicated that German telecom operator and T-Mobile parent Deutsche Telekom (NYSE:DT) had “asked its bankers to study a deal” to acquire the U.S.’s number 3 wireless carrier, Sprint Nextel (NYSE:S). The rumor mill immediately shifted into overdrive, as the pundits weighed in on the potential strengths and weaknesses of a T-Mobile/ Sprint marriage. The most pervasive argument put forth is that the combined companies would have the girth to stand up to AT&T Wireless and Verizon Wireless, which, as we’ve noted before, seem to be taking over the industry.
But as to a T-Mobile/ Sprint merger, I, for one, don’t see it. Bigger isn’t necessarily better, and, as anyone who has observed the telecommunications industry over the past five years can testify, a bad merger is WAY worse than no merger at all (Sprint and FairPoint Communications (NYSE:FRP), among others, can vouch for this). Derivative rumors have cable giant Comcast (Nasdaq:CMCSA) considering a buy of Sprint, and it was just a few months ago that the talking heads insisted Sprint was preparing to offload its Nextel unit. But what makes everyone think Sprint is obliged to do a deal?
Sprint has weathered some tough times, and it lost more than 4.5m subscribers in 2008. It also has more than $20b in debt on the books, one of the biggest causes for concern, particularly on Wall Street. But, while post-paid subscribers continued to fall in the latest quarter (-257k), Sprint has a few things going for it, and may be on its way to getting the ship turned. The last thing it needs is a big, messy deal to cloud the waters.
The first ace in Sprint’s pocket right now has got to be ceo Dan Hesse. At the helm for just two years now, it’s very possible that we’re just beginning to see the Hesse magic. Remember, this is the guy who invented the Digital One Rate plan for AT&T back in 1998, virtually eliminating the roaming charges paid by most wireless subscribers. The Digital One Rate plan up-ended the industry as competitors scrambled to compete (after resisting initially), but more importantly, it guaranteed that wireless would eventually become a wireline substitution product, and led directly to the 90%+ penetration levels in the U.S. today.
Hesse is looking to make similar paradigm shifts at Sprint, most recently by eliminating “calling circles.” The company’s Any Mobile, Any Time program, launched September 10, allows “free” calls to any mobile phone, not just to other Sprint customers, and its viral marketing web site (www.mobilegoodbye.com) has quirky music videos set to popular songs intended to get Verizon, AT&T and T-Mobile customers to not only make the switch, but also to be shared with friends (I particularly enjoyed the Goodbye Verizon song, set to Mr. Mister’s Broken Wings).
Obviously, hip marketing strategies can only go so far, so Hesse is working to make sure pricing and products are more competitive. Sprint’s Simply Everything plan includes unlimited voice and data for $100 per month. Its Boost Mobile prepaid division did well last quarter, adding nearly 800k subs as it pushed a $50 per month unlimited voice plan, and Sprint’s pending buy of Virgin Mobile (NYSE:VM) (The Deal Advisor, 08/09, p.1), as Hesse put it at a recent Goldman Sachs conference, “points to our belief that we can make money with prepaid.” The company believes smart phones are critical to future growth, and in addition to the Palm Pre, Sprint will be rolling out the HTC Hero some time this month.
Hesse also noted that Sprint has cut labor costs by 40% over two years, has been paying down debt and that the company now has enough cash to get to 2012. He said Sprint’s heavy focus on improving the customer experience has helped churn improve sequentially for the past several quarters, although he admitted that it’s still not where it needs to be. Innovative deals like its Amazon/Kindle relationship, whereby the Sprint network is utilized for book downloads to the Kindle e-reader (at no direct cost to the buyer), are further evidence of Hesse’s creativity—although word this week that AT&T will service the newest international version of the e-reader highlights Sprint’s still-tenuous position.
Finally, there’s Sprint’s Clearwire investment. Long controversial, the company’s majority ownership of the WiMax entity puts Sprint in bed with not only several major cable companies (incuding CMCSA), but also tech heavyweights Intel and Google. Clearwire has launched its 4G service in 16 cities this year, making it first to market with 4G, and intends to be serving 120m U.S. pops by the end of 2010. Notably, Sprint has dramatically reduced its annual capital investment due in part to Clearwire, which Hesse considers to be its “capex,” as data usage can be offloaded to the 4G network as it comes on-air, reducing strain on the CDMA system. (Of course, losing 10% of your subscriber base also frees up capacity!)
At the end of the day, Sprint is still struggling, but it seems to us that if anyone can save the ship from sinking, it’s Dan Hesse and his team. More importantly, it seems to us that a sale right now is the last thing that Sprint needs, particularly one with T-Mobile. A messy integration with an incompatible technology sounds too much like the Nextel deal back in 2005—and who needs another $30b write-off? The company has an impressive spectrum portfolio, competent leadership and a well-known brand name. What it needs to do in order to get its share price out from under $5 is execute. Keep improving churn and cash flow stats, pay down more debt and grab back some customers from Verizon and AT&T. IF—and we have to acknowledge that it’s a daunting task—Sprint can do these things, there might be some healthy returns on the horizon for investors.
Just for kicks, we’ve run discounted cash flow analyses on Sprint and Virgin Mobile separately and pro forma combined, to see what the market is discounting and what the upside might be. Using, we believe, conservative estimates for 2010 and 2011 net cash flow, it looks to us like Wall Street is demanding a better than 26% return on equity given Sprint’s recent price. For Virgin, it’s a slightly lower 23%. But should an investor be content with, say, an 18% cost of equity, the pro forma value per Sprint share rises to nearly $8—more than twice its recent level. Higher risk than some investment options, but hey—no pain, no gain.