Description

Thesis

The wireless industry is reaching maturity and carriers are responding to limited subscriber growth by engaging in a price war.  Sprint is the high cost player with the weakest brand, high leverage and the most risk of going bankrupt if a price war continues.  On a probability weighted basis, we believe shorting Sprint offers 30-40% upside over the next 2yrs.

Path to Profitability
The subscriber base will decline by ~3% annually over the next few yrs, ARPUs will decline by ~2-3% annually, churn will increase by ~10bps, capex will likely remain depressed at ~10% of sales and EBITDA margins will compress from ~20% to ~13% due to high operating leverage.  Sprint will start burning cash in the next 3yrs and could run into a liquidity problem unless they can get their sub base growing again.

What the Bulls Like: The bulls are focused on 4 key points.                                                                                                                                        

1) Potential for a growing sub base.  Subscribers losses will reverse and become gains as the post-paid business experiences declining churn/accelerating growth in gross sub adds and the pre-paid business continues to experience solid growth
2) ARPU will be flat to increasing over the next few years as there is a mix shift to higher priced unlimited plans and increasing penetration of smartphone users
3) Excess capacity on the network and some additional cost cutting should lead to high incremental margins as the sub base begins to grow
4) Based on consensus expectations, Sprint trades at a ~20% fcf yield

What the Bulls Are Missing: Bulls are incorrectly framing the story and are missing the fact that Sprint's recent fundamental improvements are unsustainable as they have been driven by plan/pricing adjustments made in 08/09 that competitors have now matched/undercut.  Fundamentals already started to reverse course in the latest quarter.

1) Mature Industry:  Wireless penetration has increased from 60% to 90%+ over the past 5yrs and total subscribers are now growing <5%.  In order to make sell side #s, Sprint has to increase its market share of industry post-paid gross sub adds from ~14% to 20% and its share of industry pre-paid gross sub adds from ~25% to 35% over the next 3-5yrs and that is assuming that gross sub adds stay flat for the industry (they probably decline).  Given recent price reductions made by competitors, it is going to be a battle to just maintain their current share of industry gross sub adds which will lead to a declining sub base.      
2) Price War:  Wireless carriers are currently engaging in a price war.  In just the past few weeks, we have seen T, VZ and PCS cut pricing on their unlimited plans by 10%+.  As the industry continues to push down ARPUs, Sprint will have to follow or lose significant share.  Sprint also has ~10-12% of its post-paid sub base on higher priced unlimited plans vs T/V with ~1% of post-paid subs on these plans.  If Sprint loses subs on their unlimited plans due to recent T/VZ price cuts on their unlimited plans, it could cause a step function decline in ARPUs.
3) High Cost Player:  Sprint is very levered and is the high cost player in an increasingly commoditized and super competitive industry with high fixed costs.  As the larger/lower cost carriers continue to cut prices in order to grow, Sprint's margins will get crushed.
4) Potential Bankruptcy:  On our 2010 #s, Sprint trades at a ~15% fcf yield, fcf is declining by 40%+ annually and there is a decent probability they face a liquidity crunch over the next few years.

Key Points
The Wireless Industry Has Reached Maturity:   With penetration of 90%+, growth in overall wireless subscribers has decelerated to <5% and carriers are getting much more aggressive in order to maintain growth.  

• Post-paid wireless subscriber growth is now <3% annually. With limited industry sub growth, competitors are attacking one another's post-paid subscriber base in order to grow.
• Pre-paid wireless subscriber growth is ~10-15% annually but continues to decelerate. Over the past 12 months, post-paid carriers have entered the pre-paid business in order to maintain growth.

Wireless Carriers Are Engaging in a Price War:  The wireless business is becoming increasingly commoditized and it is largely a fixed cost business with very high incremental margins/returns.   As the industry matures, carriers are slashing prices in order to maintain growth.  Prices can fall significantly further before ARPUs get close to marginal cost.  We believe we are in the early innings of an all out price war.

Sprint is the Weak Link and Could Go Bankrupt:  Sprint is highly levered, has a weak brand and is operating at a cost disadvantage as the wireless industry is entering a price war.

1) High Cost Player:  The large carriers have marginal cash costs of approximately $20-22/sub vs ~$26-28 for Sprint.   Larger carriers could cut industry pricing by ~15% and still maintain an irr/sub of 15%+ while Sprint would be forced into bankruptcy if this were to occur.
2) Weak Brand/Poor Service Quality:  Sprint's network quality is poor, it has higher churn than its larger competitors and its sub base is declining.  These trends could accelerate as they lose exclusivity on the Pre/Pixi. Once this happens, Sprint will have nothing to differentiate itself at the same time that its prices are no longer as competitive. 
3) Highly Levered:  Sprint has ~$17b of net debt with maturities of ~$1.7b in 2010/11 and $2.8b in 2012.  Assuming that industry gross sub adds stay flat over the next few years, Sprint is able to maintain its market share of gross adds, churn picks up slightly and ARPU declines by ~2-3% annually and Sprint will start burning cash. In order for Sprint to survive, they need to grow subs and maintain ARPU at elevated levels in an increasingly competitive environment.

Fundamental Improvements are Temporary:  3 core drivers of Sprint value have improved over the past few quarters which has reinvigorated bulls over the potential for a turnaround.  Although in the latest quarter, fundamentals already started to deteriorate.  We believe that the momentum behind these drivers will continue to fade/reverse in 2010:

1) Recent Fundamental Improvements:  1) ARPU declines have decelerated to 0%, 2) Subscriber losses have decelerated and 3) Churn has declined in the pre-paid business. 
2) Reason for Improvements:  All about price
a. Pre-Paid:  Sprint introduced a competitively priced boost unlimited plan in early 09 which helped drive an increase in ARPUs, a reduction in churn and reacceleration in sub growth.
b. Post-Paid: Sprint introduced a competitively priced unlimited plan (Simple Everything) in 08 and announced exclusivity on Pre/Pixi smartphones.  This helped drive a deceleration in sub losses and a stabilization in ARPUs as new customers signed up for the unlimited plans.
3) Recent Competitive Changes That will Put Renewed Pressure on Fundamentals:  Starting in mid 09, there have been several competitive responses that are likely to put renewed pressure on Sprint's performance.
a. Pre-Paid:  Tracfone aggressively entered the pre-paid space with a <$50 unlimited offering on VZs CDMA network.  LEAP/PCS reduced pricing on their unlimited plans by ~10% so they are competitive with Sprint. ATT entered the pre-paid market.
b. Post-Paid:  T Mobile released their unlimited plan at a price discount to Sprint in late 09 and started financing phones and T/VZ cut their unlimited plan pricing by ~10% reducing the price premium to Sprint.  The Pre/Pixi have just started to go multi-carrier.  If Sprint loses unlimited customer to competitors, their ARPU gets hit (unlimited is higher price) and it's game over.

Financials
BIV EBITDA #s 2010: $5.7b, EV/ EBITDA = 4.9x  and 2011: $4.6B, EV/EBITDA = 6.1x
BIV FCF #s 2010: $.60/share and 2011: $.15/share
Consensus EBITDA #s  2010: $5.8b, EV/ EBITDA = 4.8x  and 2011: $5.75B, EV/EBITDA = 4.9x

Recent Signposts
1) In January of 2010, we saw 10%+ price cuts on unlimited plans from PCS, VZ and T
2) Sprint is using CLWR for its 4G solution as opposed to building out its own LTE solution (CLWR solution is lower quality)
3) Sprint has increased advertising dramatically over the past few quarters and now represents 25% of industry ad spend vs 15% of gross sub adds
4) Sprint is making a massive push into pre-paid and is at risk of cannibalizing its higher priced post-paid base:
a. Sprint is now offering Boost service (ie pre-paid) on its CDMA network (post-paid network)
b. Sprint purchased Virgin to increase its pre-paid scale

Risks
1) Sprint is able to re-accelerate gross sub adds and get its subscriber base growing again (operational and financial leverage works in both directions)
a. Advertising continues to help network perception, post-paid unlimited price plan discount to T/VZ and pre-paid Boost unlimited offering on CDMA network drives continued share gains despite competitive responses
2) T Mobile acquisition of Sprint
a. Different networks but consolidation would help rationalize industry pricing and scale would help cost structures
3) Industry sub growth is faster than expected
a. As ARPUs come down, additional penetration helps drive sub growth
4) Big trading up affect to unlimited plans and increased data penetration that help sustain ARPUs
a. Discounts on unlimited plans help drive customers to trade up given the closing of price premium to regular plans.
b. Increasing smartphone penetration helps increase ARPUs and carriers don't cut data pricing due to network constraints
5) CLWR provides a temporary quality advantage for Sprint as T/VZ take longer than expected to roll out LTE
6) More rational industry pricing due to consolidation or concerns over price war getting out of control

Catalyst

1) Sprint loses unlimited subs due to competitive price cuts

2) Additional competitive price cuts in prepaid/post-paid by competitors 

3) Continued deceleration in industry sub growth

4) Sprint misses street expectations