Sprint (S) Needs the Palm Pre to Succeed

Sprint Nextel Corp. (S) reported fiscal fourth quarter and 2008 full year results this morning and the company managed to lose only a penny versus consensus estimates of a three cent loss. As is common, these results exclude one-time charges related their merger with Nextel back in 2005. It has been rough going for the company ever since the merger, as the two companies’ network technologies did not immediately mesh. The result has been falling revenue and significant subscribers losses. However, the market seems to have brushed aside these two continuing problems and focusing on the earnings “beat”, as the stock is up more than 27% in morning trading.

SSprint stock has been in free fall since the summer of 2007, when it was in the low $20s, and the company soon after suspended it dividend. The company’s earnings and revenue have been drooping as well, but this is the company’s first quarterly loss recently (when not taking into account charges). Revenue fell by 14% in the last year and was worse than analysts expectations, and expectations for the next year are predicting a further drop in revenue as well.

During the quarter, Sprint lost another 1.3 million subscribers with the vast majority being the highly sought after “postpaid” variety. This brings the total number of subscribers down to 49.3 million an 8.4% decline over fiscal 2007’s year end. With Sprint’s main competitor’s AT&T (T) and Verizon (VZ) gaining subscribers through the downturn, the gap between the “have’s” and the “have not’s” continues to expand. The wireline (mostly internet) business was not much better as revenues in that area dropped 6%.

It is clear that Sprint needs something to make customers stick around, and they believe that they have that silver bullet with their exclusive deal with Palm (PALM) to provide the new Pre handset. Many of the early reviews of the Pre have been quiet impressive and some tout it as the first real challenger to Apple’s (AAPL) iPhone. Well, for Sprint to return to profitability, they certainly hope so. One “must-have” handset can be a huge boon to a carrier, and with Sprint’s high churn rate it needs to give consumers something to get excited about. The release of the Pre at this point is still source of speculation, as internet message boards buzzed with the rumor of a February 15th release. Obviously, that did not happen, but it should be a good sign that the public is showing significant interest. The best that fans of the Pre can do now is sign up for updates on the Sprint web site.

We still have an Undervalued valuation on Sprint as the company’s continued loss in share price does make the stock look more attractive compared to historical norms. However, as you can tell from the previous paragraphs, we have significant concerns with Sprint as it continues to hemorrhage subscribers. Sprint cut 8,000 jobs last month which in this environment is not surprising at all. The production of free cash flow is impressive and works favorably in our analysis. Although some strides were made in the quarter, we fear that Sprint could be the dreaded value-trap. As we have stated, the company is not profitable at this point and is losing its revenue base at an alarming rate. Furthermore, the company has a substantial amount of debt on its balance sheet. Ben Graham liked to find stocks with a Debt/Equity ratio of .1, with nearly $39 billion in debt right now Sprint has nearly 20 times more debt than Graham would have liked to see.

With so much riding on the Pre release, it is worth noting that there are rumors of Apple suing Palm over patents related to the Pre’s multi-touch technology. Many who test drove the Pre at the Consumer Electronics Showcase or CES, where it was unveiled, said it was eerily similar to the multi-touch interface of the iPhone. This is certainly something for Sprint and Palm investors to keep a close watch on. As Apple’s acting CEO Tim Cook said in the most recent conference call:

“We approach this business as a software platform business. We are watching the landscape. We like competition as long as they don’t rip off our IP. And if they do, we will go after anyone who does…I don’t want to talk about any specific company. We are ready to suit up and go against anyone. However, we will not stand for having our IP ripped off.”

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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