Sprint’s Race to Profit Becomes a Marathon

It looks like a tough road for investors

   

Sprint’s Race to Profit Becomes a Marathon

When Sprint (NYSE:S) executives sat down with investors and analysts last Friday, the news sounded pretty good: The carrier will start offering wireless 4G LTE service in the middle of 2012 and will finish building out its new network by the end of the following year. At first, the stock rallied 12% on the news.

LTE is a version of next-generation 4G mobile networks, with the potential to work several times faster than the 3G networks now in use. Sprint offers a 4G service that relies on the Wimax technology of its partner Clearwire (NASDAQ:CLWR), but the extra investment would allow Sprint to rely more on its own spectrum and less on Clearwire’s.

Then came the bad news, and for investors it far outweighed the good: Sprint said the network buildout would require $10 billion in capital expenses over the next two years. To raise that money, Sprint would have to sell new shares – diluting the stakes of existing investors – or take on new debt.

Things got ugly fast. Within minutes, that 12% rise vanished and Sprint’s stock sank for the rest of the day. On Monday, it continued to sink as analysts furrowed their brows, wagged their fingers and revised their estimates. At Monday’s close, Sprint had lost 26% of the market value it had before it made its announcement.

For good measure, Clearwire, the partner Sprint was throwing under the bus to build its own costly network, lost 37% of its value in the same two-day period.

It wasn’t supposed to happen like this. According to a report that appeared only a week earlier, Sprint was planning to launch its LTE network in “early 2012” with no additional costs: “With the costs already accounted for in its prior forecast, the LTE network won’t require any additional capital investment,” CNET reported on Sept. 27. In late August, Sprint’s CEO told Engadget he had a “great story around 4G” to tell this fall.

So far, only the Sprint bears are enjoying the story. Some analysts attending the event weren’t so excited. The need to raise capital was bad enough, but Sprint dodged questions about their own sales of Apple’s (NASDAQ:AAPL) iPhone or earnings forecasts. “Sprint is un-investible until they can provide better clarity on EBTIDA, their 4G strategy and their capital structure,” wrote Walter Piecyk of BTIG in a huffy note, which pointed out that Sprint had dodged similar questions before, saying it would address them at last Friday’s event.

The iPhone issue is also a sticky one. Carriers like AT&T (NYSE:T) and Verizon (NYSE:VZ) saw their margins slim down after they began selling iPhones, because of subsidies that carriers pay to sign up new subscribers. The profit margin will increase over time, but in Sprint’s case the short-term profit hit will coincide with the network’s higher capital spending.

Piecyk’s note came on Friday. On Monday, things only got worse as six research houses downgraded the stock, including Deutsche Bank, JP Morgan and Kaufman Brothers. JPM’s Philip Cusick said the company’s executive team “needs to re-prove itself to investors before the stock can work.”

And not just to investors — Standard & Poor’s warned that it may downgrade the company’s credit rating. The cocktail of lower margins from iPhone subsidies and the new costs of upgrading its networks may be too powerful for Sprint to stomach. Or as S&P put it, the mix “could lead to near-term deterioration of profitability and key credit measures in the next few years, including higher leverage and negative free operating cash flow in 2012 and 2013.”

Sprint is now worth a little more than a third (37%) than it was only four months ago. Some contrarian-minded investors might imagine the stock has been beaten down so hard that it could be a bargain, given the chance for long-term growth thanks to iPhones and that new 4G network.

But they might consider that Sprint has $16 billion in long-term debt, several billion of which will come due in the next few years. These risky bets the company is making could hurt cash flows, which would making debt repayment tougher, as well as hurt its credit rating, which would make interest payments higher.

At the very least, Sprint’s race to profit growth won’t involve a sprint anymore. It’s looking more like a marathon.


Article printed from InvestorPlace Media, http://investorplace.com/2011/10/sprints-race-to-profit-becomes-a-marathon/.

©2014 InvestorPlace Media, LLC

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