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Morningstar | Sprint Posts Customer Losses as Promotions End; FVE Remains $5.75

Sprint returned to net postpaid phone customer losses during its fiscal second quarter, reflecting increased defections as promotional discounts expire and a pullback in promotional offers. We expect Sprint will continue to struggle to balance growth and profitability on its own, with a network that lags its rivals and a core brand that has suffered reputationally for a decade. We are maintaining our $5.75 fair value estimate and no-moat rating. We believe Sprint’s stand-alone fair value is well below its current stock price, with significant upside should the proposed T-Mobile merger close. At this point, we believe gauging the prospects for regulatory approval of the merger is difficult, leaving T-Mobile as the more prudent way to invest in a potentially combined company.

Sprint lost 34,000 net postpaid phone customers during the quarter, its first net loss in more than three years. The heavy promotions that attracted customers in the past, such as half off competitor rates and free additional lines, are steadily expiring, pushing customers to leave. Monthly phone customer churn hit 1.73%, up from 1.59% a year ago and far higher than the other national carriers (T-Mobile, the next highest, reported 1.02%). In our view, a significant portion of customers have chosen Sprint primarily based on price and will quickly switch to carrier with a better network as the pricing gap narrows.

Sprint did see a nice uptick in average revenue per customer, enabling wireless service revenue to hold roughly flat year over year, adjusted for accounting changes. Sprint has been quick to trumpet multiyear record profitability numbers, but much of this improvement is the result of continued adoption of phone leasing plans, a shift in the number of new customers taking phone installment plans, and accounting changes. Looking at cash flow, as we define it, the firm was roughly break-even during the quarter.

The cash flow result comes despite a step up in network spending to $1.1 billion from $549 million a year ago. Sprint expects network spending to take another step up during the second half of fiscal 2018, though it did trim its capital budget for the year to $5.0 billion-$5.5 billion from $5.0 billion-$6.0 billion. We continue to believe Sprint’s current network and spectrum position necessitate higher levels of spending if it hopes to keep pace with rivals’ plans. A merger with T-Mobile would, of course, completely change that equation.