Earnings Preview: Sprint

Sprint Nextel Corp. (S), the third-largest U.S. wireless carrier, is slated to release its first quarter 2011 earnings on April 28 before the market opens. The current Zacks Consensus Estimate for the first quarter is net loss of 21 cents, representing a decline of 25.32% from the year-ago level.

Sprint had average positive surprises of 6.96% in the last four quarters of 2010. We expect the first quarter to show a little positive surprise as Sprint is seeing an uptick in its post-paid wireless business. Sprint is expected to benefit from increased penetration of smartphones, rising average revenue per user (ARPU) and lower churn in the post-paid wireless segment.

However, we believe Sprint’s business has been depressed since the proposed merger of AT&T Inc. (T) and Deutsche Telekom’s unit T-Mobile USA was announced in late March. This news has faded all positive reactions that Sprint received earlier this year following improved performance and a turnaround in post-paid wireless business.The proposed merger of AT&T and T-Mobile has raised worries for Sprint.

We believe the AT&T/T-Mobile merger will not have any significant affect on Sprint’s first quarter results but will hurt its profitability through the remainder of the year.

On its fourth quarter conference call, Sprint Nextel stated that it expects post-paid and total net subscriber additions to improve annually for fiscal 2011.

Fourth Quarter Flashback

In the fourth quarter of 2010, despite outstanding numbers from the post-paid business, Sprint reported a net loss of 31 cents. The quarter’s results missed the Zacks Consensus by 2 cents but improved 3 cents year over year. An increase in the subscriber base through expanded fourth generation long-term evolution (4G LTE) services contributed to the year-over-year increase. Revenue improved 3% from the year-ago quarter and outpaced the Zacks Consensus Estimate.

Sprint added 58,000 net post-paid customers during the fourth quarter, reflecting considerable improvement from a net loss of 504,000 in the year-ago quarter and 107,000 in the previous quarter. This represented the first quarter of net post-paid additions since the second quarter of 2007.Sprint also generated the best ever post-paid churn in the fourth quarter and fiscal 2010. Prepaid churn was also the best in five years.

Agreement of Analysts

Estimates for the first quarter have been trending downward over the last 7 days, with 2 analysts out of 23 moving down and none moving in the opposite direction. Over the last 30 days, 2 analysts reduced their estimates while 2 made positive revisions.

For fiscal 2011, out of 26 analysts, 4 revised their estimates downward over the last 30 days while two moved in the same direction over the last 7 days. Only 1 analyst made a positive revision to the estimate over the last 30 days and none revised the estimate upward over the last 7 days.

The analysts are mainly concerned about the AT&T/T-Mobile merger. If the merger is approved, it might significantly alter the structure of the overall telecommunication industry. AT&T and Verizon Communications Inc. (VZ) are already the prime wireless providers and the combined company would be almost three times the size of Sprint.

Sprint’s share is eroding continuously in the U.S. wireless market due to its inability to provide competitive services. It is currently a loss making entity and its shares have lost more than 80% of their value since the announcement of the Nextel merger in December 2004. We believe the merged AT&T might further hurt Sprint’s profitabilty and shrink its subscriber base.

Further, given the U.S. has more than 95% wireless penetration, competition is likely to remain intense, which could pressure top and bottom-line results as Sprint competes to gain market share. In addition, Sprint is now no longer the only major carrier offering the 4G network. The company’s market advantage for its 4G wireless service has eroded as other carriers started offering competitive services.

However, the analyst believe that Sprint is again gaining ground from this month following new contracts wins, the appointment of the new CFO and resolved wholesale pricing dispute with Clearwire Corp. (CLWR), which was plaguing Sprint’s revenue since last year. In December 2010, Sprint announced Network Vision, a multiyear network infrastructure initiative, which could be a significant long-term margin driver. This is expected to generate $10 billion to $11 billion in savings over the next seven years.

The analysts believe all these factors will serve as a major catalyst to Sprint’s growth plan going forward.

Magnitude — Consensus Estimate Trend

Over the last 7 days, the magnitude of the first quarter estimate revisions remained static at 21 cents. For fiscal 2011, the Zacks Consensus Estimate is 80 cents, down from 79 cents over the last 7 days and 30 days. The Zacks Consensus Estimate for 2011 represents a substantial 31.92% increase from last year.

Our Analysis

We believe an attractive wireless product/service mix, wider 4G network footprint, prepaid brands like Assurance Wireless and Virgin Mobile, Boost Mobile’s Monthly Unlimited plans as well as the Network Vision initiative will continue to add opportunities in the wireless businesses.

However, we remain cautious due to lower margins in wireless and wireline, heavy expenditure involved in deploying 4G services as well as competitive threats. In addition, Network Initiative will dilute margins and free cash flow in the initial years of implementation.

We are currently maintaining our long-term Neutral rating with the Zacks # 3 (Hold) Rank.

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