Description

Sprint (FON/PCS) Capital Corp. 5.7% of 11/15/03 Senior Notes (Offer Price: 74)

Sprint senior notes are trading at distressed levels. Using the July 29, 2002 offering price of 74 (from the Bear Stearns high-yield desk), yield-to-maturity on the 5.7% of 03 notes is 31.8%. Later maturing Sprint debt issues also offer attractive returns ranging from 29.9% on the 5.875s of 5/1/04 to 13.1% on the 8.75s of 11/15/28 bonds. More conservative investors may prefer to accept lower yields in return for lower loss potential offered by the lower dollar priced, long-dated paper. These high returns are due to telecom jitters, credit market liquidity paranoia, and specific to Sprint, concerns that the company won’t be able to replace its bank facilities, which include a $3 billion 364-day facility expiring in August 2002 and a $2 billion facility expiring in August 2003. Neither of these facilities has any balance outstanding. They were put in place to back up the company’s commercial paper program. Sprint now has no commercial paper outstanding, so they no longer need $5 billion in credit lines. The Company plans to replace these facilities with a smaller unsecured 364-day bank credit facility with a one-year term out and has stated so as recently as July 26, 2002.

Sprint is rated Baa3 by Moody’s, BBB- by S&P, and BBB by Fitch. The 5.7s of 03, of which there are $1 billion face amount outstanding, share these ratings. The notes were issued by Sprint Capital Corp, a subsidiary of Sprint Corporation that holds all of Sprint’s $21 billion of debt, with the exception of $971 million of operating company debt and $550 million of debt held at Sprint Corporation, the holding company. I have valued Sprint’s four business lines and compared the sum of these values to the face amount of the total debt outstanding, and I have concluded that Sprint has asset value of over $36 billion on a conservative basis to $46 on an optimistic basis to cover the Company’s total debt from 1.7x to 2.2x, which I will demonstrate below.

If you think of Sprint as a long-distance telephone company, you are only 16% correct, because that’s the percentage of the company’s 2002 EBITDA expected to come from the Global Markets Division (the long-distance telephone business). Sprint Corporation has two “letter” or “tracking” stocks, FON, which represents the local, long distance and directory businesses, and PCS, which represents the wireless business. From a debtholder’s perspective, these distinctions are not material since the debtholders have claim to all the assets of Sprint Corporation. Therefore I look to all the assets of Sprint Corporation to calculate the value of the assets backing the debt.

The four business lines and 2002 analyst estimates are presented below:

($millions) Revenue EBITDA EBITDA %
PCS Wireless $10,811 $2,964 39.4%
Local Division $6,287 $3,110 41.3%
Global Markets Division (Long Distance) $9,038 $1,213 16.1%
PDDP-Product Dist./Directory Publishing $1,369 $242 3.2%
TOTAL $27,505 $7,529 100%
(Note: analyst revenue and EBITDA estimates are from Lehman Bros)

In Sprint’s Q2 2002 earnings release on July 18, 2002, the Company gave 2002 guidance of FON Group EBITDA of $4.7 billion and PCS Group EBITDA of $2.9 billion. This combined $7.6 billion of 2002 expected EBITDA lines up nicely with analyst expectations presented above and looks pretty good compared to 2001 actual EBITDA of $5.775 billion and LTM 6/30/02 EBITDA of $6.52 billion. Where does the growth come from? In large part from PCS, which should grow EBITDA 96% in 2002. The Local Division should grow EBITDA 3.3% in 2002, while Global Markets (LD) can expect a 13.1% decline in EBITDA and PDDP should see a 22.4% decline in 2002 EBITDA due the decline in the equipment portion of that division.

VALUATION
PCS Wireless – The PCS Wireless division 2002E EBITDA of $2,964 is multiplied by 5.5x on the low side, and 6.5x on the high side, to come up with a valuation range of $16.3 billion to $19.3 billion. These multiples compare to a 6.0 multiple, which is the average for US wireless comps.

Local Division – Besides the RBOCs, which I believe trade for 5.5x to 6.5x EBITDA and 2,500 to 3,300 per access line, I looked at two nearly pure local comps for good measure. Century (CTL) trades at 5.6x latest quarter annualized EBITDA and $2,800 per access line. Commonwealth Telephone (CTCO) trades at 6.8x latest quarter annualized EBITDA and $2,300 per access line. From these comps, I use an EBITDA multiple range of 5.0x to 6.0x EBITDA to come up with a value range of $15.55 billion to $18.66 billion. Additionally, I used an EV to access line range of $2,000 to $3,000 to come up with a value range of $16.4 billion to $24.7 billion. For final numbers I simply took an average of the values derived from each method, for a final value range for the local division of $16 billion to $21.7 billion.

Global Markets Division (Long Distance) – I conservatively used an EBITDA multiple range of 1.5x to 2.5x to come up with a value range of $1.8 billion to 3 billion. The ATT when-issued stock (ex. The broadband business) trades for a multiple of 2.5x 2002E EBITDA, for comparison.

PDDP – Sprint is exploring a potential sale of the directory publishing business and stated in their Q202 earnings release that they have a number of very interested buyers and expect to make a decision by the end of August. Most directory acquisitions are being done in the 7 to 9 multiple range these days. The QwestDex business will be acquired for approximately 8 times EBITDA, according to recent press reports. I use an EBITDA multiple range of 6.0x to 8.0 times to derive a value range of $1.45 billion to $1.94 billion, which is below the $2.0 billion expected price that has been mentioned in the financial press recently for the Sprint directory publishing business.

VALUATION TOTALS: Low High
PCS Wireless $16.3 $19.3 billion
Local Division $16.0 $21.7 “
Global Markets (LD) $1.8 $3.0 “
PDDP $1.4 $1.9 “
Cash $0.6 $0.6 “
TOTAL $36.1 $46.5 billion

Total Debt at 6/30/02 $21.1 $21.1 billion

Asset Value/Total Debt 1.71x 2.20x

As you can see, the debt appears to be well covered. This is borne out by decent credit ratios such as total debt to 2002 EBITDA of 2.8x and EBITDA to Interest of 5.0x in the most recent quarter. Which all begs the question of why are these notes offered at these levels?

The answer lies in the fact that high-grade holders were “puking” them out last week (for lack of a better term) on rumors that the company had drawn down on its credit line. The company denied this in a July 26 press release and stated that it had no intention of drawing down on its credit line, and the bonds recovered somewhat. But they still are offered at a level where I strongly believe they will not remain for long.

While there is not enough space here to go into excruciating detail on upcoming debt amortization ($450mm in H202, $1.4 billion in 03, $1.2 billion in 04), downgrade triggers (<$700mm), etc, etc, I feel the company will be in a position to refinance upcoming maturities in future years, and I feel Sprint’s sound fundamentals will allow it to remain at an investment grade rating.

Catalyst

I believe panic selling by high grade sellers will abate quickly as the distressed community focuses on the fantastic yields and strong asset coverage of Sprint senior debt and bids it up. An announcement on the directory publishing sale should come by the end of August. I expect the 5.7s of 03 to trade to a YTM of less that 20% by the time Q3 earnings are released. A 20% yield equates to a dollar price of 84.4, for more than 10 points of upside in the next 3 months.