Sprint CQ2 2016 Earnings: Where Do Fundamentals and Valuation Meet?

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“Like most stocks, Sprint’s shares go up when their results get better,” said Craig Moffett of MoffettNathanson LLC. “That may seem obvious, but it isn’t as obvious as it sounds… and, to be clear, Sprint’s results are indeed getting better,”  he said.

Monday’s report from MoffettNathanson gave the following review of Sprint’s 2nd Quarter earnings:

“Recent Sprint’s shares have rallied back from a steep start-of-year decline and are now up nearly 30% YTD, arguably on the back of rising expectations that they are “doing better” (and also to developments at SoftBank).  And indeed, results reported today confirm that, at least in some areas, things are improving.  Most importantly, their subscriber rolls are growing, even if only modestly, with a better-than-expected 173K post-paid phone net additions in Q2, their fourth consecutive positive result.   

But at what valuation?  Measured by conventional accounting, without the artificial boost that comes from counting lease revenues while excluding their associated handset costs, Sprint’s wireless business is currently trading at 6.5x trailing twelve months EBITDA.  Their “real” EBITDA growth is still negative, ARPU is still falling (albeit now at a slower pace), and free cash flow remains negative despite exceedingly low capital spending.

A few weeks ago, we (at MoffettNathanson) observed that Sprint is in the process of transitioning to a next-gen service provider, where handsets are taken out of the equation entirely, offloaded to third parties who will both own and finance them for customers.  Conceptualizing Sprint in this way makes it much easier to grasp the fundamental valuation question.  Viewed through this lens, Sprint is a between 20% and 25% EBITDA margin business on a full-year basis with what will likely be about 20% long-term capital intensity, yielding net zero FCF before financing costs.  Financing costs are another 11% of revenues.

Unless something changes dramatically – have they found a magic elixir that will allow them to spend less on their network than any of their peers going forward, for example? – there is just no plausible case for Sprint equity at anything like these levels… regardless of whether Sprint is or is not doing “better.”

The stock rose $1.24, or nearly 27%, to $5.85 per share in Monday afternoon trading. The stock hit a new 52-week high of $5.93 earlier in the day. Year to date, Sprint shares are now up 61%.

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