Sprint: Dan Hesse’s departure is a bigger positive than not buying T-Mobile.

The investment case for Sprint rests on valuation and fundamentals.  We think Sprint’s valuation reflects the company’s tawdry past and does not factor improvement from SoftBank or its $12 to $15B ($3.00 to $4.00 per share) in excess spectrum. 

Based on this, we think Sprint can sell above $10 in the relatively near term.  Thinking longer term, we see no reason why it cannot sell for two to three times that.  We see very little downside in Sprint stock.  The company has ample cash and liquidity in excess of its maturities through at least the end of 2016.  Moreover, we believe it is hard for the company to do worse than its current performance. 

Valuation

Sprint has about 4.0B fully diluted shares outstanding.  At a $6.00 share price, Sprint’s market cap is $24 B.  It has net debt of $27.5B making its enterprise value is $51.5B.  During the last 12 months, it generated about $4.0B in EBITDA.  According to Sprint’s segment reporting, Wireless generates about $5.2B and Wireline did about than $285 MM during the last 12 months.  This implies corporate consumes about $1.5B.  We see lots of room for improvement.  By our calculation, Sprint’s overall EBITDA margin runs in the mid to high teens. 

With Dan Hesse in charge, we expected Sprint would have generated about $3.5B EBITDA in the next 12 months.  With effective management, the $4.0B should at least hold but more likely increase. We suggest using $4.0B as a baseline for EBITDA. 

Source: CapitalIQ and proprietary estimates

These numbers do not argue for a massive re-valuation.  We think Sprint and T-Mobile should sell for higher multiples and earn higher returns than AT&T and Verizon.  Neither of the smaller companies has massive wireline businesses as the giants.  We believe, and can demonstrate how the large wireline operations hurt both growth and profitability.  Right now and according to CapitalIQ, AT&T and Verizon generate 35% to 40% EBITDA margins while Sprint and T-Mobile are in the low 20s. 

Obligations:

At the end of June, Sprint had about 9.1B in total liquidity.  Cash was $5.5B, its bank line had $2.4B available and its had $1.2B in unused service receivables facility.  In total the company has $32.5 in total debt which is due according to the schedule below. 

Source: Sprint, $ amounts in millions

Why Sprint’s margins will expand:

• Masayoshi Son/SoftBank/New Management
• A much-Improved  Network to Attract Customers
• More than enough spectrum for the future 

We expect these elements will improve both top line growth and margin for Sprint. 

SoftBank/Masayoshi Son and New Management

Masayoshi Son is a winner.  Sprint’s old board and management were losers.

Given Masayoshi Son’s comments about T-Mobile, US regulators, and Sprint, we think he may well have been humoring Dan Hesse’s with T-Mobile.  The new CEO, Marcelo Claure has a great track record as founder and CEO of Brightstar.  We do not seem him tied to old line Sprint as Hesse was.  This is a major positive.

Sprint ought to be a business case of what not to do.  The board has second guessed management for decades.  It hired Dan Hesse and then compensated him to destroy value rather than enhance it.  We see Sprint’s Clearwire strategy and execution as a good example of Hesse’s destructive capabilities. 

We had been frustrated that Masayoshi Son was taking too long to replace Hesse.  We are thankful he finally did this.  Sprint’s new CEO is Marcelo Claure.  He started the wireless distributor Brightstar where, until August 11, he remains as CEO.  In January 2014, SoftBank paid $1.26B to buy 62.3% of BrightStar.  It will now buy the remaining 37.7% from Claure for $298MM. 

Details of SoftBank and BrightStar.

Block Graph showing SoftBank's process for acquiring BrightStar

Source: SoftBank

While we know little about Claure, we do know and admire Brightstar as a very well-run wireless distributor.  For the last several months, Claure has been engaged in studying Sprint.  As a result, we expect to see a very different and improved company within the next 12 months.  It will likely take three to six months for his plans and actions to become obvious. 

Will SoftBank Buy More Sprint Stock?

Shortly after SoftBank recapitalized Sprint; it purchased 72.6 MM shares at an average price of $6.69.  We would not be surprised to see SoftBank buy additional shares on this break. 

T-Mobile, nice but not necessary 

Dan Hesse felt Sprint needed T-Mobile to succeed.  We disagree.  Sprint can do better without T-Mobile during the next 2-3 years.  Over a longer time, one less competitor would be a positive. 

We like T-Mobile management and the potential cost synergies.  Operationally, we did not see what else T-Mobile brought to the table.  With recent spectrum purchases, T-Mobile improved its position.  However, it still needed to buy more. 

T-Mobile’s network operates in different frequencies than Sprint’s does.  T-Mobile’s voice network is GSM.  Sprint’s is CDMA.  Integration would be challenging.  It would probably not be as challenging for Sprint as Nextel, but it would be challenging.  Integration would also have left Sprint’s piles of excess spectrum unused.  We are a big fan of managements that use their assets before buying more. 

Expect Massive Network Improvement

Sprint has been hemorrhaging customers largely due to poor network performance.  It is just now starting to turn on a better network.  We expect this network will be generally available by the end of 2015.  As important, Sprint has plenty of Spectrum to expand network capacity and coverage. 

We believe customers choose their carrier based on price and quality of service.  The following graph shows a history of Sprint’s Quarterly Postpaid Net Additions from 2006 through mid-2014.  For a little more than two years, Sprint sold a superior network and it added customers.  When it stopped selling that network, it went back to losing customers.

 Colored Columnar Bar Graph showing how Sprint started losing customer when Dan Hesse joined, than gained customers when it marketed WiMAX, then lost customers when it stopped marketing WiMAX

Source: Sprint, Clearwire, tBBI

Today, Sprint’s network usually shows up as having the lowest ratings.  The reason, Sprint's capex was only $2.0B per annum from 2009 through 2011.  Since then it has stepped up by spending $4.3B in 2012 and $7.0B in 2013 and we expect it will spend at least another $7.0B this year.  This is just now, starting to improve quality.  The benefits should become visible next year. 

Sprint very wisely rebuilt its 3G network with the newest multi-frequency; multi-protocol base stations.  This makes it easier to upgrade to future generations and to accommodate different frequencies.   These base stations also run Sprint’s 200 MM POP LTE (4G) network. 

Right now, Sprint is adding new technology it calls Spark to its LTE network.  Spark is service that we expect will deliver the fastest 4-G network speed in the US if not the world.  Spark works by using all of Sprint’s frequencies to deliver the highest speed data.  Think of it as similar to Docsys which enabled cable companies to combine channels to increase internet speed. 

Sprint says Spark is in seven markets today.  We think it is more likely in seven neighborhoods.  We believe Spark will deliver the best network experience of the four major carriers.  Now that Hesse is gone, we expect the company to roll out the Spark network more aggressively.  We expect the combined benefits of Spark and LTE will aid Sprint in achieving our forecast of positive postpaid net additions for 2015. 

Sprint’s Spectrum Gold Mine

We see Sprint as having a gold mine with its spectrum holdings.  The company has flexibility to sell or employ this spectrum.  With about 195 MHz of spectrum coverage nationwide, Sprint about equals AT&T and Verizon combined.  The FCC restricts each of those to 100MHz nationwide.  These three compare to T-Mobile, which we estimate has between 65 and 75Mhz of nationwide coverage.

We see spectrum as a reasonably fungible asset.  However, it is only fungible if it is not in use.  Right now, we estimate that Sprint has about 45.7 B MHz/POPs of unused spectrum.  Some of this, like the WCS and 900 MHz are odd lots and we assign an arbitrarily low value to them.  We estimate Sprint still has about 2.1B MHz/POPs of 800 MHz spectrum unused.  We see 800 MHz as very desirable and likely to sell above our liquidation estimate.  We value Sprint’s massive 2.5 GHz position at Clearwire’s purchase price.  Given the number of offers Clearwire turned down for its spectrum, we think this is a low value.  We believe SoftBank/Sprint can attain higher returns by employing the spectrum rather than selling it at anywhere near the prices we suggest. 

Source: tBBi

We estimate Sprint will not use more than 50% of its excess spectrum during the next three years.  Should it so desire, it could sell this spectrum.  At $0.40 per MHz pop, which we see as low value, the excess would be worth about 9.1B.  At $0.75 per MHz pop, which probably represents the upper bound, the excess spectrum would be worth $17.1B. 

We believe there is an active and expanding set of buyers for this asset.  We believe that the FCC will increase limitations on spectrum ownership, which will enable AT&T and Verizon to buy more.  Likely buyers for Sprint’s excess include AT&T, Verizon, T-Mobile, Dish, one of John Malone’s holdings or even American Movile or other foreign carriers.  That said, we doubt Sprint will sell this important asset.  Because its large holdings provide ample bandwidth, we expect Sprint will achieve higher future returns (or undercut) than competitors that must continually buy spectrum. 

Like so much of Sprint, its spectrum is controversial.  About 70% of Sprint’s airwaves are in the 2.5 GHz band.  This is the most popular LTE band in the world.  In the US, 2.5 GHz is substantially higher frequency than the big carrier’s 700 MHz/900Mhz networks and somewhat above their AWS (1.7/2.1 GHz) and PCS (1.9 GHz) networks.  Lower frequency spectrum carries further and penetrates buildings better than higher frequency spectrum does.  This is critical for voice, not so important for data.

Assuming a constant network technology, LTE or CDMA for example, one MHz of spectrum carries the same amount of data in any frequency.   In other words, 10 MHz of 700 MHz spectrum delivers the same amount of data as 10 MHz of 2.5 GHz.  It can carry that data further but cannot deliver more bandwidth. 

The problem with low frequency spectrum is that it generates more interference with itself.  This is very important for voice where coverage counts.  It is less important for data where capacity counts.  Low frequency can carry it further but has problems serving very high-density markets and indoor applications.  We think this is a key factor why AT&T and Verizon seem to prefer Wi-Fi to small cells in licensed frequencies. 

Two years from now, we expect Sprint will provide the vastly better service than the big four.  In three to five years, we believe it will provide the best.  This is a key reason we believe Sprint’s future returns will be higher than its past.