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Contrarians Beware: Sprint Nextel Is No Prize
Posted: Apr 01, 2008 15:09 PM by Ben McClure
Contrarian investors believe it's wise to buy when everybody else is selling. It sounds simple enough: Just wait until the market is really pessimistic about a company, and then snap up its stock.
No doubt, at this minute some courageous investor is putting in a purchase order for Sprint Nextel Corporation (NYSE:S). The wireless telecom service giant has seen its stock fall by a whopping 70% since June 2007. With the deep drop, Sprint might just turn a few investor heads. However, bottom fishers will be dismayed to find out that, even after the drop, at $6.76 Sprint Nextel is still a risky proposition. I reckon the value of Sprint Nextel stock could fall further in 2008.
Why is Sprint Falling?
From a historical perspective, and relative to peers AT&T (NYSE:T) and Verizon Communications (NYSE:VZ), the shares are way down, but for good reason. Sprint Nextel continues to lose customers by the boatload. Post-paid subscribers, which are much more profitable than the pre-paid subscribers, are falling at an accelerating rate. In the third quarter of 2007 they fell by 337,000 individuals. In the fourth quarter, 683,000 defected. Now the company says it will lose 1.2 million post-paid subscribers in the first quarter, or more than its total subscriber loss last year.
In a desperate act the company is slashing monthly prices on its unlimited plan, which encompasses all of its cell phone services. This might slow the rate of customer defections, but it also runs the risk of slowing revenue growth and pushing down profit margins. And it increases the likelihood of a price war that competitors AT&T, Verizon and T-Mobile - a war the competition is much better equipped to wage.
Liquidity Problems
More disturbing than the mass customer exodus are corporate actions that signal the possibility of a liquidity crunch. Sprint Nextel has suspended its dividend and let its share buyback program lapse. Last month, it borrowed $2.5 billion in revolving debt. The bank covenant on these loans allows total debt leverage of 3.5 times trailing earnings before interest taxation, depreciation and amortization (EBITDA). Sprint's debt-to-EBITDA ratio is currently 2.5, but revenue and earnings erosion could push the ratio over the limit.
Despite the drubbing they've received in the past year, the shares still look pricey. At a share price of $6.76, the company has a market capitalization of about $18.8 billion. Let's assign to Sprint Nextel a forward PE ratio of 16, about the same PE ratio attached to Verizon. Based on that multiple, Sprint Nextel will have to produce about $1.2 billion net income or an EPS of 41 cents per share in 2008 if share prices remain constant. Yet, Wall Street earnings estimates say that this number is well beyond reach. Analysts say the company is on track to produce just 8 cents per share in 2008 according to Market Watch.
Whispers of a Takeover
Rumors abound that Sprint Nextel is attracting corporate suitors according to Ed Ketchoyian of Seeking Alpha. In theory, of course, AT&T, Verizon and T-Mobile all have big enough balance sheets to make them candidates for pursuing a takeover. But it's unlikely any one of them would consider forking over cash or shares to grab Sprint Nextel’s most valued customers when those customers are freely defecting on their own.
At the same time, in today's shaky equity and credit market environment, few private equity investors will have the stomach for a company already stretched to its debt limits. Meanwhile, Sprint Nextel shares will probably need to fall much further to draw the interest of a non-traditional buyer like Google (Nasdaq:GOOG).
The Future of Sprint
The bottom line is that betting on Sprint Nextel at today's share price remains, at best, a long shot. Taking into consideration the evacuation of customers, and the reduced income, it's hard to be optimistic. By my reckoning, the shares could have further to fall. Now might not be the time to have a contrarian attitude.
For more on contrarian investing, check out Finding Profit In Troubled Stocks.
By Ben McClure
Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.
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