Description

DESCRIPTION:
Recommendation is long S stock. Priced as of 11/16 @ $24.27

BUSINESS OVERVIEW:
• Sprint Corporation (pro forma for the wireline spin) is a “pure play” domestic wireless play trading at 4.5x 2007 EBITDA compared to US wireline/wireless peers trading at an average of 4.5x 2007 EV/EBITDA
• We expect 2007 EPS pre spin of $2.05 or $2.25 (10.8x) at the approproiately capitalized balance sheet.

INVESTMENT THESIS SUMMARY:
• One of the best balance sheets in the telecom industry.
• Robust growth outlook and financial transactions that management should affect over the next 12 months.
• The first step that has been widely discussed is the divestiture of Sprint’s ILEC business during 2Q 2006. Although relatively small (worth $3 per Sprint share) the transaction is strategically important as it assigns roughly $8B in debt to the wireline business “liberating” the wireless assets to pursue accretive transactions through the use of it’s under levered balance sheet.
• Post ILEC divestiture, we believe Sprint will accretively (FCF basis) acquire NXTP and APCS gaining increased scale and improving its growth profile funding the purchases with debt. Much has been made of the onerous and potentially dilutive nature of the Nextel Partners negotiations and has acted as an overhang on the stock. To put the impact in perspective, if Sprint were to acquire the remaining interests in NXTP at market prices (assumed to be $25) following an arbitration period, Sprint would have to issue roughly $4.5B in debt increasing leverage by just 0.3 turns. Even if Sprint paid a 20% premium for both Nextel Partners and Alamosa, the impact on the capital structure and earnings power would be diminimus. We estimate a 20% premium would reduce the combined entity’s earnings and free cash flow power by only $0.02!
• Pro forma for a NXTP and APCS deal, we estimate S is trading at 4.5x EV/EBITDA (2007) with just 0.8x debt/ebitda leverage.
• Assuming mgmt levers the balance sheet to 1.5x, FON could retire 15% of the shares outstanding producing fully taxed EPS of $2.25 on a pro forma $21 stock ($3 for ILEC) creating a security trading at just 9.3x 2007 EPS

Conservatively we believe the business should be awarded a 15x P/E multiple + $3 in other assets and spectrum option value to arrive at $37 mid year 2006 or 50% + upside. Risk/reward in our opinion is $2 down / $13 up.

Estimates follow below. Pro forma estimates assume the following.
• 2006 Wireline divestiture is assumed to have had occurred Jan 1, 2006
• Nextel Partners and Alamosa fully consolidated Jan 1, 2007
• We believe a more appropriately capitalized balance sheet supports minumum 1.5x leverage. To achieve the leverage we model Sprint borrows $11 billion at year end 2006 and retires 521M shares roughly 17% of the float. We also assume 6% interest rate on the debt.


EPS EBITDA Net debt Leverage P/E EV/EBITDA
2005E $1.50 $8,700M
2006PF $1.61 $12,550M 0.8x 13.2x 5.6x
2007PF $2.25 $16,000M 1.5x 9.5x 4.5x

DOWNSIDE RISK IS LIMITED SUPPORTED BY CASH FLOW GENERATION
The three main risks to an investment in Sprint are 1. US wireless growth sharply decelerates and turns negative. 2. ARPU declines faster than expected. 3. The integration of the Sprint and Nextel networks result in disruption and subscriber losses

Assuming none of the above mentioned catalysts actually transpire, I believe downside risk is limited supported by the company’s strong cash flow characteristics. In the most recent quarter, Sprint generated adjusted OIBDA of $3,671M (+10% yr/yr).

Using 3Q annualized data assuming steady state (no growth and no synergy) Sprint would look like the following

EBITDA = $14.7B
Net debt = $16.4B
Mkt Cap = $72B
EV = $88.4B
EV/EBITDA (LQA) = 6x

Catalyst

1. ILEC spin accomplished at some point in 2Q:06
2. Affiliate appraisals and transacstions are resolved.
3. Post ILEC spin, management can communicate the appropriate capitalization for a 90% wireless business.