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Market Update

Sprint Handling Increased Competition Well

Sprint ended 2013 on a relatively solid note but investors should remain cautious and wait for a more attractive price before diving in, says Morningstar’s Mike Hodel.

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 Sprint (S) ended 2013 on a relatively solid note, returning to postpaid customer growth during the fourth quarter while sharply improving margins versus a year ago. The results during the quarter and management's outlook for 2014 were both largely in line with our expectations. We don't expect to make a material adjustment to our fair value estimate, and our moat rating is unchanged. Speculation regarding a potential transaction with  T-Mobile US (TMUS) continues to whip Sprint's shares around. While we believe a merger is critical to improving the competitive position of both firms, we see long odds to completing a transaction in the near term. We remain cautious on Sprint and would look for a more attractive price before considering the shares.

Sprint added 58,000 postpaid customers during the fourth quarter, a surprisingly strong result given the turmoil at the firm recently (closing the Softbank and Clearwire deals over the summer while investing aggressively in the network). While tablet sales padded customer numbers, we estimate that Sprint lost only about 150,000 postpaid phone customers during the quarter, a nice improvement versus a year ago. This performance comes despite the resurgence of T-Mobile as a competitor over the past year and actually bests the results that  AT&T (T) posted during the period (we estimate the firm lost about 450,000 phone customers). Sprint's management expects to lose postpaid customers during the first half of 2014, with growth returning in the second half as Network Vision winds down.

Sprint generated EBITDA of $1.2 billion during the quarter, up 46% year over year. The benefits of the iDen network shutdown, cost savings from Network Vision, a reduction in the number of customers upgrading phones, and modest network growth more than offset increased costs resulting from the acquisition of Clearwire and Network Vision spending. Management expects EBITDA growth of at least 20% during 2014, in line with our estimates.

Despite the improvement in profitability, Sprint burned through $2.8 billion during the quarter, bringing the total cash burn for 2013 to $4.6 billion. Capital spending for the year totaled $7.0 billion ($7.4 billion on an accrual basis), short of the $8 billion forecast management had provided. Sprint again is projecting $8 billion of spending during 2014, which is higher than we have modeled. Increasing our spending estimate has only a small impact on our fair value estimate. More important, Sprint plans to invest aggressively to deploy LTE coverage using 2.5 GHz spectrum in the back half of 2014, putting its spectrum advantage to use. The firm hopes to cover 100 million people with 2.5 GHz capacity by the end of the year. 

The cash burn in 2013, coupled with the Clearwire transaction, pushed net debt to $25.5 billion from $16.1 billion at the start of the year. Net leverage now stands at 4.8 times 2013 EBITDA and 3.9 times projected 2014 EBITDA. Cash burn should moderate in 2014, but net debt will continue to move up during the year. With leverage high and growing, we believe Sprint still needs to undertake additional strategic moves, including a deal with T-Mobile US, to put itself on more solid competitive ground against AT&T and  Verizon (VZ).

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Michael Hodel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.