Description

Thesis

Clearwire's roll-out plan will fail.  The end result will be either bankruptcy or substantial dilution for existing equity holders.  Either way the stock is going down.

Note: This is not a call on the quarter today (though I did want to give VIC members a look at this before they report).  I have no idea how it is tracking, I just think this business model/capital structure won't work.

Background

Clearwire is a wireless network service provider.  It currently provides its service via laptop data cards and fixed wireless modems for PCs that don't move.  Essentially users can pay $30-$60 per month for the service.  $30/mo gets you 1.5 Mbs downloads and 0.5 Mbps uploads from a fixed location only (you might as well have dial-up this is so slow).  $40/mo buys you 6.0 Mbs down and 1.0 Mbs up (about half as fast as a wired cable high speed Internet connection) from home.   If you want mobile Internet you can get 6.0 Mbs down and 1.0 Mbs up for $40/mo, but only on the Clear 4G network.    You can get a home modem and laptop on the go service for $55/mo. For $60/mo from Sprint you can get mobile data that will roam onto the Sprint 3G network when you don't have Clear 4G coverage.  Clearwire's 4G network is based on a technology called Wimax (more on that later).  At Dec. 31, 2009 the company had operations in 61 markets covering 44.7 million people (POPs).  In the US they have 4G covering 34.5 mil subs in 27 markets.  It had 642k retail subs and 46k wholesale subs.  4G subs are 392k (the rest are pre-wimax) retail and 46k wholesale.  Wholesale subs are subs that Sprint, Comcast, Bright House, bring on.  They should generate less ARPU, but also less CPGA.

Clearwire has already died and been resurrected twice.  Legacy Clearwire was the brainchild of Craig McCaw (of McCaw Cellular fame see:  http://en.wikipedia.org/wiki/Craig_McCaw ).  He started piecing together the spectrum and building out a pre-wimax service that was a flop.  McCaw ran liquidity worries after the IPO of CLWR and heavy cap ex spend and, always the consummate dealmaker, convinced Sprint to contribute its 4G spectrum (Clearwire had been bidding against them to acquire it) in exchange for a 51% stake in Clearwire.  At the time of the Sprint infusion, several other partners took equity stakes including Time Warner Cable, Bright House, Comcast, Google, Inte in exchange for cash infusions at $17 per share.  Death and resurrection #1.  Then last year, the company was nearly out of money so in November it accepted another $1.54 billion equity infusion from Sprint, Comcast, Time Warner, Intel, Eagle River (McCaw), and Bright House at $7.33 per share (Google opted out).  Sprint was $1.18 bil of this. There is also a rights offering to allow the newly diluted shareholders to up their stake at $7.33 per share (CLWR-R).  The company was also able to issue $2.8 bil of 12% 2015 notes to retire its credit line.  The investment banking associate who put a slide in the deck suggesting the spectrum was worth up to $20 bil should go to jail (more on this later).

A note on jargon:  You will want to read the CLWR 10K to learn about ARPU, CPGA, Churn, MHzPOPs, Spectrum, etc.  For those with home building backgrounds think of spectrum as raw land you have to buy from the FCC.  You can build houses (wireless towers) on it and if you build enough you have a neighborhood (network) and all the added value that comes with it.  Like land, they don't make more spectrum.  But also like land, there are beachfront pieces of spectrum and there are pieces of spectrum that are next to a landfill and worth very little.

The Bull Case

The bulls on this one think CLWR is a winner because:

• 1) There is real demand for wireless broadband (just ask an iPhone user on AT&T).
• 2) CLWR will garner a significant first mover advantage by rolling out 4G nationwide before AT&T or VZ do.
• 3) The CLWR spectrum is very valuable.
• 4) Clearwire has a cost advantage.

I will refute these in turn:

• 1) I actually agree with the bulls here. I do think there is demand for wireless broadband. I also think Clearwire's network will be around for many years. The problem is grand scale wireless roll-out usually end up being a good deal for the third owner (the first are the equity holders, the second is the bank, the third is the equity emerging from bankruptcy). See MetroPCS and Leap Wireless which both went bankrupt before becoming viable operators. The other problem right now is that Clear only really offers data cards, which is a limited market. Eventually they will expand into smartphones (a Sprint 4G phone is coming in June), but the reality is today they are not really even in the smartphone game.
• 2) This is simply untrue. Verizon will roll out LTE to 25-30 metro areas by year end. http://www.pcmag.com/article2/0,2817,2361799,00.asp AT&T is lagging but will have LTE by 2011. T-mobile has committed to LTE but the roll out plan is not clear. There are some rumors they have been talking about using terrestrial spectrum owned by Harbinger's satellite network. Harbinger is actively rolling out their service. MetroPCS is rolling out LTE this year. With only 600k subs the first mover advantage has been almost no advantage at all. Indeed, given the false start in pre-wimax and CLWR CEO Bill Morrow's recent comments
• 3) Clearwire sports an EV of $5.9 (932 mil (A&B) shares x 7.59 = $7.1 bil less $3.8 bil cash plus 2.7 bil debt) and controls 44 billion MHZ-POPs of which 59% are leased. These leases represent $11.6 billion in future obligations and run about $345 mil per year. Discounted over 33.6 years at 12% (CLWR's cost of debt) and you should have $2.6 billion in additional debt on the Clearwire balance sheet to account for the leased portion. That brings the total adjusted EV to $8.5 billion. As cash shrinks due to cap ex this EV will rise. So the EV/MHzPOP is $0.19, a modest premium to the satellite guys (ICOG, Skyterra, and Globalstar) which range from $0.06-$0.16 EV/MHzPOP. However, spectrum is only really worth what someone will pay for it. At Auction 86 the FCC auctioned 1.77 bil MHzPOPs of BRS spectrum (CLWR's type) for $0.011 per MhzPOP in October of 2009. http://wireless.fcc.gov/auctions/default.htm?job=auction_summary&id=86

http://hraunfoss.fcc.gov/edocs_public/attachmatch/DA-09-1376A2.pdf

How could anyone even begin to imply this spectrum may be worth $20 billion?

• 4) I believe this is wrong. Clearwire has spectrum in the 2.5 Ghz band. This requires more cell sites per area than the 700Mhz band or 1900MHz band Verizon and AT&T operate in. See: http://searchmobilecomputing.techtarget.com/tip/700-MHz-Why-is-it-so-valuable?ShortReg=1&mboxConv=searchMobileComputing_RegActivate_Submit&

So I think Clearwire will have to spend much more per area covered to populate their network.

Additionally, I understand that Clearwire uses wireless backhaul between sites which requires line of site between towers (and should make for a tricky network buildout).  Finally, almost all major players except Intel and Motorola have thrown their weight behind LTE.  Cisco recently dropped Wimax to pursue LTE only.  http://www.computerworld.in/articles/cisco-quits-wimax-radio-business

 This should mean low costs for LTE. 

Also, the big boys will start using wireless backhaul if it is cheaper too.

Other issues:

• How will the wholesale model workout?  Why will Comcast, Bright House, Time Warner want to sell Clearwire service to compete against their profitable HIS offering.  Only Sprint who has no other good options makes sense as a partner whose interests are aligned with Clearwire.  BTW Clearwire is the biggest off balance sheet liability (due to future equity infusions) for Sprint if any of you liked biv930's Sprint short.
• What happens when CLWR has to start subsidizing phones like every other U.S. Carrier?  That will cost a lot.
• Also Morrow was recently quoted as saying Wimax may merge with LTE.  http://www.sidecutreports.com/2010/03/24/clearwires-morrow-lets-merge-wimax-lte/
• I'd hate to have to see CLWR retrofit their existing sites and switch to LTE mid-stream.

Risks:

• Sprint and others keep ponying up to keep this going.  This still likely results in dilution though.  Sprint has few other options than to keep injecting, but they may run into their own liquidity crunch.
• Investors believe spectrum is worth a lot.  I think I have shown it's not, but the markets can be irrational longer than one can be solvent.
• This is a levered company.  The stock will be volatile.
• There is not that much float.
• Since there are no real earnings quarter to quarter manipulation of other metrics may occur and drive the stock.
• There is demand for wireless broadband, I just don't think Clearwire is the winner.

Numbers

Needless to say Clearwire is losing a boatload of money.

All number mils                 2008                       2009                       2010E

Rev                                        $20                         $269                       $577

OIBDA                                   ($234)                   ($764)                   ($764)

Cap Ex                                   ($738)                   ($1,540)                ($1,924)

Subs                                      0.5                          0.6                          1.7

Cover POPs                        18.2                        44.7                        90.0*

ARPU                                    $39.12                   $39.60                   $39.60

CPGA                                    $456                       $564                       $450

Churn                                    2.7%                      3.1%                      2.8%

*Note the company claims they will cover 120 mil POPs by year end.  I am more skeptical.

Catalyst

• Dilutive capital raise by the end of the year.
• Increasing competition from VZ, AT&T, MetroPCS, Harbinger, Etc.
• Wimax loses out to LTE and Clearwire is orphaned.