Tuesday, October 9, 2007

Friday, September 14, 2007

Sprint Update

S - Intrinsic Value Range: $7 to $10

Valuation: Our valuation model yields a price of $10/share for the rest of 2007. For the next five years, our model uses a CAPM cost of equity of 11.45% with a beta of 1.15, five year CAGR of 4% for revenues and net profit margin of 7%. In perpetuity, the model uses a CAPM cost of equity of 12.85% with a beta of 1.4, a CAGR of 3 % for revenues and net profit margin of 14%.

Revenues: Sprint’s revenue growth rate will decline to 2% in 2007 due to the high customer churn Sprint is experiencing from Nextel’s customer base. Wireless market is saturated with high penetration rates among mobile subscribers and future growth in wireless sector will come from non-voice data services or customer acquisition (at a significant cost) from competitors. Leap Wireless and MetroPCS are successfully targeting Sprint’s niche low end customer segment with unlimited calling plans. At this point, it is difficult to see how Sprint can make up lost ground without any major competitive advantage. Sprint has placed a large bet on the WiMax network to stop its current downslide and get back onto a recovery path next year as it adds WiMax customers; Revenue growth for 2009 through 2011 is expected to be in the neighborhood of 7% (Figure 1). However, returns on WiMax investments will be slow to materialize due to unavailability of WiMax devices.

Wireless Revenues

(in millions, except ARPU)








Items

Q2-06

Q3-06

Q4-06

Q1-07

Q2-07

2006

2007E

2008E

2009E

2010E

2011E

Net, new Post-paid subs

0.210

-0.188

-0.306

-0.220

0.016

-0.504

-0.800

0.400

0.800

1.000

1.200

Net, new Boost subs

0.498

0.216

0.171

0.275

0.169

1.160

0.800

1.000

0.900

0.800

0.500

Net, new Wholesale subs

0.000

0.205

0.876

0.513

0.188

1.081

1.000

1.000

1.100

1.300

1.500

Net Subscriber Additions

0.708

0.233

0.741

0.568

0.373

1.737

1.000

2.400

2.800

3.100

3.200

Post Paid ARPU

$62.00

$61.00

$60.00

$59.00

$60.00

$61.00

$59.00

$59.00

$60.00

$61.00

$61.00

YoY Change

-6%

-6%

-5%

-5%

-2%

-2%

-2%

0%

1%

1%

0%

Total Wireless Revenues

8,524

9,072

9,004

8,723

8,800

35,115

35,817

37,250

39,485

42,249

45,629

YoY Change

8.00%

4.00%

9.00%

2.00%

3.00%

NM

2.00%

4.00%

6.00%

7.00%

8.00%













Wireline Revenues












Net Operating revenues

1,641

1,626

1,635

1,598

1,600

5,913

5,617

5,336

5,016

4,715

4,385

YoY Change

-5%

-6%

-2%

-4%

0%

NM

-5%

-5%

-6%

-6%

-7%

Source: Company Reports












Figure 1

Industry Analysis: Sprint operates in a highly competitive and capital-intensive telecom industry that typically provides anemic ROA. Sprint’s WiMax network is geared towards providing high speed wireless data services with low capital expenditures. Sprint’s competitor, namely Verizon, is investing in a high capex fiber-to-home network to provide high speed wired data services. Currently, Sprint is the only major telecom service provider that is prepared to offer high-speed wireless data services in 2008. Overall, companies in this industry have high fixed costs and minimal marginal cost of selling an additional minute of service; hence the industry suffers from perennial cutthroat competition. Eventual winners in this industry will be companies that can provide more services with minimum capex and generate maximum revenues from their networks.

Key Financial Ratios with Operating Lease adjustments

Ratios

Without Capital

Leases

With Capital

Leases

Debt to Equity Ratio

42.00%

64.00%

Asset Turnover

0.407

0.364

Financial Leverage

1.92

2.15

Return on Assets

2.34%

2.09%

Figure 2

Profitability Analysis: Sprint’s ROCE (Figure 3) has been highly volatile over the last five years; some of this variance can be attributed to the Nextel merger. Overall, Sprint has been reducing COGS and investment in PPE&E while steadily reducing leverage by repaying long-term debt. Although, Sprint’s long-term debt increased by one billion over the last one year, it was due to a recent spate of acquisitions. Inspite of a slight increase in profit margin since 2002; a two point reduction in financial leverage and 0.7 point reduction in asset turnover caused a decline in ROCE.

Figure 3

ROS increased marginally since 2002; a 4.62-point decrease in COGS as a percentage of sales (Figure 3) was the main driver for increase in ROS. A decrease in depreciation and severance expense was offset by an increase in amortization. Asset turnover increased slightly between 2002 and 2006 while Financial Leverage decreased by three points to 2.14. Total assets as a percentage of sales (Figure 4) declined by 32 points whereas equity increased by 71 points. The decline in asset was due to a 75 point reduction in net PP&E and a 52 point reduction in capital leases since 2002. A decline in liability as a percentage of assets (Figure 4) over the last five years has been due to a lower increase in long-term debt and a reduction in capital lease liability.

Modified Common Size Statement: Assets as % of Sales

PERIOD ENDING

Change

2006

2005

2004

2003

2002

ASSETS

Since2002

Modified Common Size(Assets as % of Sales)

Current Assets








Cash and cash equivalents

0.0%

5.0%

30.9%

19.3%

11.9%

5.0%


Marketable Securities

0.0%

0.0%

6.1%

2.1%

0.0%

0.0%


Accounts Receivable, net

-2.9%

11.2%

14.5%

14.4%

14.1%

14.1%


Inventories

-0.4%

2.9%

2.7%

3.0%

2.9%

3.3%


Deferred Tax Assets

-1.6%

2.2%

6.2%

4.8%

0.1%

3.9%


Prepaid Expenses and other current assets

2.1%

3.8%

2.7%

2.5%

1.4%

1.7%


Current assets of discontinued operations

-1.2%

0.0%

3.2%

0.0%

2.1%

1.2%

Total current assets

-4.0%

25.1%

66.3%

46.1%

32.4%

29.1%








Investments

0.6%

0.6%

8.8%

1.3%

0.0%

0.0%

Property, plant and equipment, net

-74.6%

63.0%

81.0%

104.5%

132.8%

137.6%

Capitalized Lease (Operating lease adjustment)

-51.7%

28.8%

47.3%

69.4%

78.5%

80.5%

Intangible assets








Goodwill

54.3%

75.3%

73.9%

20.3%

21.6%

21.1%


FCC licenses

25.5%

47.6%

62.6%

15.6%

16.6%

22.1%


Customer relationships, net

17.7%

17.7%

30.0%

0.1%

0.0%

0.0%


Other intangible assets, net

5.7%

5.8%

4.7%

0.1%

0.1%

0.1%

Other Assets

-3.3%

1.7%

2.2%

2.8%

5.6%

4.9%

Non-current assets of discontinued operations

-1.9%

0.0%

27.3%

0.0%

0.0%

1.9%

Total non-current assets

-27.8%

240.5%

338.0%

214.2%

255.2%

268.3%

TOTAL ASSETS

-31.7%

265.6%

404.3%

260.3%

287.6%

297.4%










Common Size Statement: Liabilities as a % of Assets

LIABILTIES

Change

2006

2005

2004

2003

2002

Current Liabilities

Since 2002

Common Size (Liabilities as a % of Assets)


Accounts payable

-1.3%

3.2%

3.1%

4.7%

4.6%

4.5%


Accrued expenses and other liabilities

-0.3%

4.8%

4.0%

5.2%

5.4%

5.1%


Current portion of LTD & capital lease

-2.0%

1.0%

4.3%

2.3%

1.0%

3.0%


Current liabilities of discontinued operations

0.0%

0.0%

0.7%

0.0%

0.0%

0.0%


Total Current Liabilities

-3.6%

9.0%

12.1%

12.2%

11.0%

12.6%









Long-term debt and capital lease obligations

-10.4%

19.3%

17.2%

28.2%

28.7%

29.6%

Capital Lease (adjustment for Operating lease)

-51.7%

28.8%

47.3%

69.4%

78.5%

80.5%

Deferred tax liabilities

6.0%

9.3%

8.9%

3.9%

2.9%

3.3%

Pension and post-retirement benefit obligations

-2.5%

0.2%

1.2%

2.6%

2.7%

2.8%

Other liabilities

1.4%

2.6%

2.4%

2.0%

1.7%

1.2%

Non-current liabilities of discontinued operations

-3.3%

0.0%

1.7%

0.0%

2.9%

3.3%


Total non-current Liabilities

25.0%

42.3%

43.1%

63.3%

66.2%

67.2%


Total Liabilities

-28.5%

51.3%

55.2%

75.6%

77.2%

79.8%

Figure 4

Risk Factors: All current ratios have increased over the last five years due to a gradual decline in current portion of long-term debt as a percentage of total assets. ROA in 2006 was 2.09%, which is lower than the cost of debt (7%), a major cause of concern for all long-term debt; any material change in long-term debt will trigger changes in NI and ROCE. Based on Sensitivity Analysis (Figure 5) of ROCE; it is most sensitive to Goodwill impairment, SG&A and COGS projections. Goodwill is unlikely to change materially in the next few years; however, SG&A and COGS could increase as Sprint improves its network and customer service to reduce churn.

Figure 5