Description

Sprint Nextel is a domestic wireless company that operates both CDMA and iDEN networks that include postpaid offerings under the Sprint and Nextel brands as well as pre-paid offerings under the Boost brand. The company also owns a long distance business that consists of long haul fiber as well as a 2.5ghz spectrum for the purposes of building out and operating a 4G Wimax (802.16) OFDM wireless broadband network.

Beginning with the recent history of the company in order to answer the 'why the company is misvalued' question, the company was formed after the merger of Sprint with its CDMA network and Nextel with its iDen push to talk network. At the time, the FCC decreed that the Nextel iden network was interfering with state and local government walkie talkie service and so ordered Nextel to re-band its spectrum. During the re-banding process, the company was aware that 1/3 of the spectrum would be unusable by its subscribers. However, the company believed that a certain vocoder could be used to compress packet signals and therefore not cause capacity issues even though 1/3 of the spectrum was unusable. However, the vocoder did not work and the Nextel network suffered capacity issues resulting in dropped calls and terrible voice quality. Considering the customer perception associated with a faulty network, subscribers began churning off the Nextel base and the company did not push gross adds on Nextel, resulting in subscribers losses for the company as a whole. This has continued and while the company now says that the Nextel network is at top quality and they will begin pushing gross adds on Nextel through new advertising, most of Wall Street doesn't believe it. Adding to the losses, Sprint has not innovated with CDMA handsets until recently and has therefore suffered low gross adds on the CDMA side. However, the company is doing well with its new HTC phones and has said they will be releasing great new CDMA handsets at CTIA in early April 2008. I believe this story is mispriced because customer perception lags in terms of network quality and Wall Street is unfairly assuming that it will not improve for another year to year and a half. Essentially, the sell-side was wrong in assuming in Q3 06 that the company would turn around operations by Q3 07, which they did not and teh sell side does not want to take a risk in assuming a turnaround now. However that is related to low gross adds on CDMA because of poor handset quality and because of not pushing gross adds on Nextel. I believe that a turnaround will occur within the next year because they are moving Nextel subscribers over to CDMA with their new CDMA Push to Talk offering called QChat and they are innovating handsets on CDMA in order to improve customer perception and retention. They are also starting a new advertising campaign under the new CEO, Dan Hesse. Moreover, the company is misvalued because the new CEO, Dan Hesse, has a history of under-guiding short term so the stock goes down before he is granted his options; he did this at Embarq and is now doing it at Sprint by forecasting abysmal net add losses in the -1.2mm range for Q1 and Q2 08.

There are two scenarios in which I see value being realized in this company. The first is in the operational turnaround that I alluded to earlier in which the stock could triple over the next year. The second is related to an asset value breakup of the company in which the stock could double over the next year. 

Beginning with an operational turnaround; assuming conservatively over the next year that Sprint is able to retain its current CDMA base, IE gross adds-churning customers equals 0, a very conservative estimate and that the iden subscriber base goes down from the current 12mm to a core 7mm base that either stays on iden or transfers to CDMA, a very conservative estimate, then assuming $235 in EBITDA per subscriber (very conservative compared to historical $275-300 EBITDA per wireless sub) and 33mm subscribers total on the postpaid side, with $55 ARPU (again, conservative), we have $22bln in 2008 revenue and $7.7bln in 08 EBITDA. Combine that with the $875mm in Long distance EBITDA and attribute zero value to the 5mm subsribers on Boost prepaid for purposes of being even more conservative and you're at the company currently trading at 4x EBITDA. In such a situation with conservative estimates, I believe the company should be trading at 7.5x EBITDA given the reproduction value of wireless assets and thus fair value for the stock is $17 and an almost tripling of the stock. From a FCF yield perspective, assuming $8.3bln in EBITDA, $300 in neg working cap, $5000 in capex (as guided by company), taxes and $988mm in interest payments, we get about $2000mm in FCF or a 12.6% FCF yield (16% FCF yield using maintenance capex), exceptionally high for a company with tangible barriers to entry and a strong brand name, staying power and FCF growth.

Assuming we do not see signs of a turnaround occuring near term and the stock stagnates, there is the breakup value potential in which a buyer comes along, potentially a cable company that wants a quad play offering or a foreign telecom provider in a saturated market that wants scale advantages in terms of handset and equipment procurement by having additional assets (both SK Telecom in Korea and KDDI and Docomo in Japan fit this criteria) comes in and buys Sprint. In a break up situation, we look at the asset value of the company and can derive a $12 very conservative stock price. In this case we look at the value of Sprint's Wimax 2.5ghx spectrum. 90 mhz covering 300mm pops at $0.25/mhz pop values it at $2.35/share. This is a conservative value for the 2.5ghz spectrum because Sprint owns so much of it and this is potentially the only band of spectrum in the entire country that is at a high enough frequency and is large enough to support a mobile broadband offering 10 yrs down the road when most of the country requires mobile broadband connections. Also, Nextwave, a company that has been buying similar spectrum has spent between $0.25 and $0.55/mhz pop for smaller amounts of spectrum that can't be used as well as Sprint's. Next, assuming all subscribers are cut off the iden network and it is sold for its spectrum value, 14mhz covering 300mm pops at $1.00 (700mhz auction spectrum which is essentially the same as the iden spectrum just sold for an average of $1.25/mhz pop, but this was not nationwide coverage like Nextel's is), puts us at a Nextel iden spectrum value of $1.46/share. We value the long distance business which Abovenet, Level Three, XO or Time Warner Telecom would love to own at 8x $825mm in 08 EBITDA, again very conservative compared to 9-12x for recent acquisitions in the space, giving us a per share value of $2.44 for the LD business. Valuing Boost pre-paid at $450/subscriber, compared to LEAP and PCS trading at $1500/sub gives us $0.78 per share. Finally, as mentioned before we atttribute no value to the Nextel post-paid business except for spectrum and we value the Sprint CDMA post paid business at a very conservative $1290/subscriber for 26mm subscribers compared to acquisitions in the past in the $2000-3000 EV/subscriber range, giving us a range of $11.66/share of Sprint. We finally subtract debt per share of $6.26, giving us a conservative asset liquidation value of $12.44 or double the current stock price.

Alternative Form of Playing the Stock:

Alternative to buying the stock outright, this can be played through the LCAPA stub. Liberty Capital is a tracking stock issued by Liberty Media Corp to track the performance of certain media and telecom assets that it owns. LCAPA's public assets include Sprint, Time Warner, Viacom, Embarq and Lodgenet. Notable private assets include Starz Media, the Braves and True Position. Lehman, banker to Liberty, has a good model that walks through the NAV calculations for each of LCAPA's assets. Valuing the public assets at market, Starz at $3.41/share, transaction value, the Braves at $3.77/shr, transaction value, True Position at 8x 08 EBITDA and other assets at equally conservative values, the total asset value of the portfolio comes out to $46/share of LCAPA. Subtracting $30/share in exchangeables, $6/shr in other debt, $7 in tax liabilities from liquidation of public assets, $5.30/share in derivative adjustments and adding $15.80/share in cash, we get to an NAV value of LCAPA of $17.44. In this case, in order to isolate Sprint at best as we can, we will stub out Time Warner and Viacom (the only public assets large enough to be stubbed out). Subtracting public values of $11.72/share of LCAPA of TWX and $2.29/share of LCAPA for Viacom, we get an NAV of $3.43 for our LCAPA stub, which is currently trading at $1.56. However, given the logic above on Sprint, if we were to assume fair value of Sprint to be $12, then we add about $3 to the value of our LCAPA stub. If we fully tax, we add $2, making NAV for our stub $5.43, which is another way to play Sprint with even greater upside plus continual buybacks of stock by Liberty. The equation for the stub is as follows on Bloomberg: LCAPA Equity - .076861 * VIA Equity - .791886 * TWX Equity.

Catalyst

Sprint will launch qChat in Q2 08 and so will be able to migrate subscribers over to CDMA from iDen and so boost iden capacity in order to begin pushing iden gross adds in Q1 08, which they already have begun. Also, they will re-invigorate their handset lineup, which they have started in q1 08 with the HTC Touch touchscreen phone, which is currently channel checking very well. So, given an improvement in net adds, which is what Wall Street is really focusing on and the reason for the low multiple on the stock, the main catalyst is an operational turn around in the company. Moreover, plenty of strategic and financial investors have looked at the company and will continue to look at it, at these levels where liquidation value provides so much upside. Thus, there are multiple catalysts to realizing value short term on the stock.

In playing LCAPA, catalysts include stock buybacks by John Malone as well as an increase in value in the underlying Sprint stock--though there may be no way of fully unlocking Sprint value increases since the Liberty companies have historically always traded at a discount to NAV.