August 13, 2014
- Sprint Corporation (NYSE: S)
- $5.80 recent share price
- 3.495 billion shares
- $49.88 billion enterprise value
- $8 to $9 FVPS range
- Expectations deflated with Sprint’s stock price down ~50% from its 52-week high
- 80% ownership by “Outsider”-like CEO Masayoshi Son/SoftBank provides rock-solid financial/operational backstop
- Softbank’s turnaround of Vodafone Japan blueprint for managing the Sprint asset
- Industry-leading network a massive competitive advantage
- Adj. BVPS of $6.62 provides downside protection
- 40% revenue growth and 35% EBITDA margin yields 7-year IRR of 17% to 20%
I like simple ideas that fit onto one page, and this is one of them – a detailed analysis of pre-Nextel Sprint, pre-SoftBank Sprint or even the U.S. telecom market is not required to assess the asymmetric nature of an investment in Sprint Corporation common stock at present levels. At its December 2013 52-week high of over $11 per share, an investment in Sprint required flawless execution of SoftBank’s turnaround plan; at a recent $5.80 per share, you pay 88% of adjusted tangible book and receive a SoftBank turnaround for free.
SoftBank Turnaround. In less than 8 years, SoftBank grew Vodafone Japan revenue 60%, operating income 500%, and generated a ~35% EBITDA margin by engaging in a massive price war with Japanese telecom leader DOCOMO and growing share of net subscriber additions from 5% to 45%. With Verizon and AT&T projected to command over 69% of the 2015 subscriber market, SoftBank sees huge opportunity for a similar type of outcome here in the United States.
While admittedly a “reductionist” form of thinking, I am a big believer in following the experts who know far more than I do about a particular industry. I have followed Dish CEO Charlie Ergen now for several years, and I do not believe there is anyone better in the telecom industry that publicly shares so much technical knowledge. The following quote by Ergen on Dish’s 2Q14 conference call is informative with regard to the current investment opportunity in Sprint:
“You’ve got to – I think Sprint’s – there is a lot of things I like about Sprint. I think they’re really entrepreneurial. They’ve got – they just got a new CEO who is probably the right guy for the competitive nature that – wireless is going to get very competitive. It’s going to get just – I’d almost say you ain’t seen nothing yet. I mean, I think you have to have a lot of respect for what T-Mobile’s done and John Legere and his team have done. But I think Sprint is capable of much, much more. They have a better spectrum position, more spectrum. And Dan Hesse did a great job in terms of transitioning that company and basically saving that company and he did a great job in selling that company, but now they’ve got the right guy for a war. And so I like what Sprint’s doing.”
Network Advantage. After Sprint’s 2013 purchase of Clearwire, it now has the deepest spectrum portfolio in the industry; and with Network Vision winding down, it can focus on fully developing a lightning-fast LTE network over the next several years. Industry-leading speeds and huge capacity, especially in densely-packed cities, affords Sprint the ability to offer unlimited data at moderate prices – a huge advantage when engaging in what promises to be a large-scale price war with the Big 2. Again, at risk of being reductionist, I believe Sprint’s network advantage is confirmed by 1) the bidding war for Sprint by SoftBank and Dish back in 2012/2013, and 2) another Charlie Ergen quote from Dish’s 2Q14 conference call:
“And I think that Sprint, particularly with the management change they’re making and with the leadership of SoftBank is – and with their spectrum position is going to be really, really a fast network, particularly in the big cities.”
Balance Sheet. For all of Sprint’s historical financial issues, it actually has a relatively clean balance sheet. After eliminating intangible assets, adjusting FCC licenses upward by 50%, and adjusting long-term deferred taxes downward by 50%, I estimate Sprint’s net operating assets are approximately $53 billion. Sprint’s capital structure consists of $27 billion of net debt and $26 billion of tangible equity. Tangible equity is approximately $6.62 per share, providing reasonable downside protection at Sprint’s current quote.
Valuation. For valuing Sprint’s upside, I essentially model the Vodafone Japan turnaround implemented by SoftBank: 7-year time frame, 43% revenue growth and a 35% EBITDA margin. To get there, I assume that over the next 7 years Sprint’s market share (of the top-4 telcos) climbs to 25% (from a projected 15.5% in 2015), and that Sprint’s revenue per average subscriber falls to $500 (from a projected $564 in 2015). The FCFE-based valuation model assumes a terminal PE of 12.5 times fully-taxed earnings, and the EBITDA-based model assumes a terminal EV/EBITDA multiple of 6 times, for an equity fair value of $8.02 and $9.12 per share, respectively.
Catalysts. While there are no hard catalysts presently in the works, at least to my knowledge, there are numerous potential “events” attached to this investment. Given Charlie Ergen’s public affection for Sprint’s network and the recent failed bid for TMUS, I believe a S/DISH tie-up is a strong possibility. Dish’s extremely valuable “virgin” nationwide spectrum portfolio would be a fantastic addition to Sprint’s network, and I imagine Dish’s content would not be terrible either if paired with Sprint’s mobile offerings. Or perhaps Sprint simply bids for Dish’s spectrum portfolio and leaves the satellite business behind. Who knows – maybe even Carlos Slim makes a run for Sprint, or perhaps Sprint and T-Mobile get together several years from now. Regardless, SoftBank’s 80% ownership and turnaround plan are “events” in and of themselves, and with the downside well-protected by the balance sheet, the risk/reward of an investment at around $5.80 is a highly attractive proposition.