Sprint Can Weather Perfect Storm of Fraud Probe, Nextel, iPhone

NEW YORK ( TheStreet) -- Sprint Nextel ( S), the Kansas wireless communication company, recently surprised the street with a healthy beat above estimates. Unfortunately for shareholders, almost as soon as corks from champagne bottles hit the ceiling, sharks started swimming in circles around the company's moat.

Members of Glancy Binkow & Goldberg have announced an "investigation of Sprint Nextel" -- "investigation" being code for "We don't have as much as we would like yet, but we really are hoping someone might come forward with a smoking gun." I don't blame lawyers for their inventiveness, but maybe jury members should have to demonstrate an ability to balance a checkbook to qualify.
Shares of Sprint were already trading near 52-week lows before news of a potential fraud investigation out of New York State.

Reuters' Karen Freifeld reported a potential $300 million liability from Sprint based on whistleblower allegations of tax fraud in New York State. In a nutshell, New York alleges Sprint failed to collect and remit cellphone service taxes as a means of gaining a competitive advantage over rivals including AT&T ( T) and Verizon ( VZ). The amount of taxes in dispute is $100 million; however, triple damages are possible in a worst-case scenario if allegations prove correct.

With the news of possible fraud, shares of Sprint already trading near 52-week lows fell an additional 5% to trade near $2.30. With such a low per-share price, shares in Sprint have become more or less a stock option without an expiration date.

Sprint investors are likely to have a ride like in A Perfect Storm, but without the sad ending. Investors should be prepared as news washes against the side, driving the shares higher or lower. Often highly volatile and emotionally charged stocks can provide the most opportunity for gains. There are ways to soothe the weak stomachs as the seas get wild, and I will describe how.

For now let's look at the seas Sprint is competing in and what to expect.

AT&T is finding life without an exclusive contract to sell iPhones easier said than done. AT&T's fast iPhone additions have virtually come to a halt, and Verizon is essentially in the same or worse situation. While Verizon didn't have an exclusive contract with iPhone, the reputation enjoyed by Verizon in comparison with AT&T virtually assured a mass migration from AT&T. It appears the migration has come to a halt and is waning as real competition for iPhone sales is a reality with three major carriers offering the "must have" phone.

Sprint continues to be plagued by Nextel. While Sprint lost 29 cents a share last quarter, 18 cents of the per-share loss are shutdown charges related to Nextel. For current Sprint investors, Nextel is a pain; for prospective investors, the Nextel situation may provide real opportunity to buy Sprint cheap. Sprint reported an overall loss in contracts due to Nextel, although the Sprint brand produced a net add of more than 250,000 contracts. The day is coming soon when board members will finally get to take a Nextel sign out to a grassy field with sledgehammers in tow to release their collective stress.

Unsurprisingly to me, with the rapid growth smartphones have experienced in the past five years, average revenue per user has increased. Sprint reported $59.88 average revenue "per contract user" last quarter. With an improvement of $1.29, this represents a revenue increase of 7% over the same period last year. I consider this a very "big deal," and the additional dollars will at some point fall to the bottom line. Sprint is just starting with Apple ( AAPL), but given time the additional revenue is a positive sign.

Overall, the quarterly loss of 29 cents was better than Wall Street's estimates of about a loss of 41 cents.

While many questioned the commitment of Sprint to gain iPhone sales, Apple is so far proving how dominant it is in the marketplace. iPhone sales have slipped from last quarter but are still adding to net contracts and likely long-term profits. As the smartphone space matures, I believe Sprint is best positioned to take market share from rivals. Sprint's lower-cost data plans make Sprint especially attractive to the same people who make the most of their smartphones/iPhones.

Sprint completely turned around its customer service issues, perhaps the most troubling aspect of the company, and now ranks as well as any other major carrier or better.

If I was to make a list of stocks most likely to double in the next 24 months, Sprint would be on the short list. Once the problems of Nextel are gone and Sprint is able to report without Nextel dragging it down, we can expect sentiment to finally shift. Even so, I like to hedge my risk and put as much in my favor as possible. If I am going to hold a position for a long time, I want to get paid for doing so.

Sprint doesn't have a dividend, but options can lower the risk and volatility of owning such a volatile stock. I am looking at selling August $2.50 put options for about 35 cents each -- providing the owner the right but not the obligation to sell Sprint at $2.50 a share anytime until expiration.

My maximum loss if Sprint goes to zero is $2.15, and my maximum gain is 35 cents for a 16% gain in four months if Sprint closes at $2.50 or higher on the expiration date. I also entered into a long position with Sprint earlier today. Covered calls are basically the same as selling puts. Buying the shares and writing calls will provide nearly the same returns.