Sprint Nextel: Bull and Bear Cases - TheStreet

Sprint Nextel: Bull and Bear Cases

We've gathered the views of credit and equity analysts on the future of Sprint business -- and Sprint stock.
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NEW YORK (TheStreet) -- Sprint Nextel (S) - Get Report is a classic mixed bag.

On one hand, Sprint Nextel continues to achieve reduction in subscriber losses as the company's management works to boost postpaid and prepaid subscriber growth. As Morningstar analyst Michael Hodel puts it, "Sprint's bread-and-butter postpaid business is finally showing faint signs of life."

Likewise, Sprint, which is trying to gain a competitive edge in the 4G services market, released its much-anticipated EVO 4G smart phone in the first week of June. It's also hoping to win new customers with wireless gadgets coming to the market later this year, as larger competitors such as

Verizon Communications'

(VZ) - Get Report

and

Vodafone's

(VOD) - Get Report

Verizon Wireless joint venture, and

AT&T

(T) - Get Report

seek new growth markets outside the saturated U.S. mobile phone market.

Then there's the other hand -- the bad hand: Sprint's EVO launch was noticeably less successful than the company had initially thought, serving as another reminder that investors will continue to monitor the company's progress in stemming customer losses against a backdrop of heavy competition coming from Verizon Wireless, for example. Verizon's also expected to bring 4G services to the market this year.

Meanwhile, although Standard & Poor's analysts appear fairly bullish about Sprint stock, they also contend that it continues to be one of the weakest national wireless carriers. The stock carries risks -- such as near-term free cash flow pressures, offset by the company's strong balance sheet and operating expense reductions -- the analysts recently noted in a report to investors.

UBS analysts, in the meantime, emphasized that they're closely watching Sprint's next move regarding wireless service provider

Clearwire

(CLWR)

, which was 56.2% owned by a Sprint subsidiary as of the end of March; Sprint's EVO connects with Clearwire's high-speed WiMax wireless network. As of Mar. 31,

Intel

(INTC) - Get Report

,

Google

(GOOG) - Get Report

,

Comcast

(CMCSA) - Get Report

,

Time Warner Cable

(TWC)

,

Bright House Networks

and

Eagle River

together owned a 33.2% stake in Clearwire.

"If Sprint management has confidence in its 4G future it could be better off taking control and increasing its stake in Clearwire now," UBS analysts recently said a a research note.

Want to learn more about analyst opinions on Sprint Nextel stock? Read on for bull- and bear-case views....

Bull Case Highlighted in Morningstar Credit Research Report:

The market has focused on Sprint Nextel's recent troubles rather than the assets it holds. Given its current trajectory, the firm should put up decent customer growth going forward. A stable customer base will enable a sharp improvement in margins and likely a reassessment of Sprint's value.

As the third-largest carrier in the U.S., Sprint will play an important role in the industry one way or another. Stabilizing the business should allow shareholders to benefit whether Sprint consolidates the industry, gets acquired or goes it alone.

Bear Case Highlighted in Morningstar Report:

While Sprint has struggled, Verizon Wireless and AT&T have benefited at its expense. Fending off these much larger rivals will be increasingly difficult as data services become more important to the industry -- only AT&T and Verizon have the resources to invest in spectrum and technology needed to keep pace with demand.

The wireless industry is at a critical juncture. Phone service still provides the bulk of revenue -- at least based on customer perception -- but voice is an increasingly small portion of the traffic on data networks. Convincing customers to continue paying high prices for phone service or for the data capacity they use could prove very difficult, to the detriment of industry profitability.

Bull Case Highlighted in Morningstar Credit Research Report:

Sprint is the only one of the big three wireless carriers not affiliated with a major local phone company. This independence will make it the partner of choice for cable companies and others looking to offer wireless services to their customers.

Bear Case Highlighted in Morningstar Report:

Combining Sprint and Nextel has proved far more difficult than had been the case with other recent wireless mergers -- and full integration, if it ever happens, is still years away. Rather than simplifying things, the firm has taken on yet another complication in its venture with Clearwire.

Standard & Poor's Stock Rating:

Buy with price target of $6.

Standard & Poor's Research Report Analysis:

S&P's buy recommendation is largely based on valuation. In its view, the company is in a transition, trying to regain favor with customers, as competitors take market share. However, S&P believes Sprint is making progress, as subscriber losses continue to decline sequentially.

The company has also done a good job of continuing to bring on new and exciting handsets and smartphones to retain and draw subscribers. While S&P thinks Sprint has a long way to go in turning around its operations, it believes the shares are nonetheless attractive at recent levels.

Risks to S&P's recommendation and target price include higher capital spending to deploy new services, liquidity issues relating to declining cash flow, and increased competition from nationwide peers that could lead to delayed growth in subscriber additions.

S&P's 12-month target price of $6 assumes an enterprise value of 5.5 times its 2011 EBITDA (earnings before interest, taxes, depreciation and amortization) estimate, slightly below larger-cap telecom peers, to reflect Sprint's subscriber losses, and below smaller pure-play wireless carriers that S&P thinks have stronger growth prospects.

UBS's Stock Rating:

Neutral with price target of $4.

UBS Research Report Analysis:

UBS believes Sprint's valuation cannot be correctly assessed without the inclusion of Clearwire's financials. As Sprint management often states, Clearwire is Sprint's 4G strategy. Similar to a company attempting to sell 2G services today, Sprint will likely see its fundamentals begin to deteriorate within the next three years unless it takes control of Clearwire and consolidates its financials. As a result, UBS believes Sprint will try to take control of the company in conjunction with Clearwire's next fund raise. UBS's Clearwire model suggests the company will run out of money in the first half of 2011, making it likely the company will try to raise additional funds within the next six to 12 months.

On a standalone basis, Sprint shares look cheap at 4.5 times UBS's 2011 EBITDA estimate and a 20% FCF (free cash flow) yield. On a combined basis and after including synergies and NOL (net operating loss), UBS believes Sprint trades at 7 times 2011 estimated EBITDA with a 9% cash flow yield. Given the major difference in size of the two companies, the combination of Sprint and Clearwire does not meaningfully change the growth rate of Sprint, despite the new, higher valuation. Due to UBS' expectations for continued weakness in postpaid at Sprint and rapidly fading first mover advantage at Clearwire, UBS remains on the sidelines and maintains its neutral rating on Sprint shares. Its 12-month price target is based on DCF (discounted cash flow) analysis.

RBC's Stock Rating:

Outperform, above average risk with price target of $6.

RBC Research Report Analysis:

Management appears to be targeting flat to modestly growing revenues in 2010 compared with 2009, with some potential for modest growth. With respect to EBITDA margins, RBC believes the aim is for stabilization during 2010, with growth targeted for 2011.

Management is targeting a return to aggregate subscriber growth -- postpaid plus prepaid -- and still expects a sequential narrowing of postpaid losses in the second quarter. Should Sprint's postpaid metrics show marked improvement, management appears poised for potential competitive reactions. With respect to 4G subscribers, it's not clear how the company's reporting practices might change going forward.

In the next two years, the company has $5.2 billion of debt maturities -- including $750 million this month and $1.65 billion in 2011, and $2.75 billion in 2012 -- that should be paid down in cash -- the balance was $4.4 billion in the first quarter 2010 -- reducing annualized interest expense by $300 million to $400 million. The company recently negotiated a new $2.1 billion unsecured revolver. The reduced capacity compared with the prior revolver signifies the company's confidence in its cash-generating abilities -- coupled with its $4.4 billion cash balance in the first quarter of 2010.

Priority uses of cash include: network capex (capital expenditures) in the range of $1.5 billion to $2 billion annually; rebranding expenses, currently $700 million annually, but expected to decline considerably in 2011 and beyond; and a potential follow-on equity investment in Clearwire -- perhaps in the $1 billion to $2 billion range -- to further the 4G buildout.

Sprint management appears inclined to continue to provide cash funding to Clearwire, likely at levels that would increase its proportionate level of investment relative to Clearwire's other partners, perhaps to the low-60% range. From an operational perspective, Sprint management wishes to see a continuous 4G buildout effort; thus, RBC believes Sprint would be eager to avoid delays in Clearwire's next funding round.

Following AT&T's recent price tiering actions, RBC believes it's unlikely Sprint would follow suit. Currently, the carrier charges $10 extra per month for users of its EVO 4G handset, even those based in non-4G markets.

The EVO appears to be selling well despite some shortages. RBC believes margins associated with this device may not be as attractive as 3G-only devices due to payments to Clearwire for 4G services. Management expects another 4G-capable phone launch later this year.

RBC's $6 price target is based on a DCF (discounted cash flow), plus the addition of Sprint's 56% Clearwire ownership. Deterioration in the competitive or operating environment for postpaid, prepaid or data services, or failure to achieve ARPU (average revenue per user), churn or subscriber targets, represent potential impediments to RBC's price target.

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-- Reported by Andrea Tse in New York

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