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Sprint: Not Out, but Winded

By Alex Salkever For the past two years, NASCAR fans have seen Kyle Petty speeding on paved ovals in a car emblazoned with the Sprint logo. No more. On July 9, the Overland Park (Kan.) telecom giant announced it wouldn't renew its sponsorship of stock-car racing's first family as part of ongoing cost-cutting measures. With most primary sponsors for Winston Cup series racing cars coughing up $5 million or more a year, struggling Sprint could hardly justify the expense.

How ironic. A mere 18 months ago, Sprint (FON) was rushing forward to expand its networks and roll out a fast third-generation (3G) wireless-data service. Now, with the telecom sector reeling from the loss of Wall Street's confidence and savage price wars, Sprint is slamming on the brakes. It's cutting capital spending to stem the red ink and has laid off 12,000 employees since last fall.

Downgrades of Sprint debt to one level above junk by both Moody's Investors Services and Standard & Poor's in June effectively closed off the capital markets for the time being. And investors have sent Sprint's stock down nearly 50% from $20 a share in January, 2002, to around $11 per share as of July 10.

WHAT'S THE ROI? Whether Sprint CEO William Esrey will be able to arrest the decline remains an open question, as slowing growth in wireless subscribers and continued margin pressure in its long-distance business could weigh heavily on the company.

Still, Sprint is hardly the next WorldCom (WCOME). In fact, WorldCom's impending bankruptcy may be allowing Sprint to pick up some long-distance customers in the short term. But it seems unlikely that the sector's brutal competition will abate. With the WorldCom debacle revealing that the huge telecom profit margins promoted during the late 1990s were questionable to say the least, no one knows what the real return on investment will be in long- distance. And most suspect it will be far lower than previously anticipated.

These questions may depress Sprint stock, but it's not all bad news. Sprint says it will burn through only $500 million or so in cash over the next year and will be cash-flow positive in 2003. CEO Esrey also claims that the debt downgrades have more to do with the fallout from Enron than with Sprint's performance. "Nothing has changed in what we've told rating agencies. But in many cases, the rating agencies have changed their criteria," he says.

BACKBONE PAIN. As for the slowdown in wireless growth, Esrey acknowledges that the heady days are over. "But that's the wrong way to look at it," he argues. "The reality is, a year and a half ago the average [wireless] customer was using 350 minutes a month. Today, he's using 600 minutes. Wireless is getting a bigger percentage of the telecom dollar than it used to. There's going to be a shift to wireless." Meanwhile, steady revenues from its local-phone unit should help tide Sprint through.

It has already put out feelers to sell its directory business, which could bring in billions more in cash. With 2001 revenues of $26 billion, Sprint has two major units and four basic lines of business. The FON Group unit holds three of those lines: global markets, local service, and directories. The global-markets division runs Sprint's long-distance and data services, including its Internet-backbone operations, which serve the U.S. government and thousands of corporate customers. It contributed $9.9 billion in 2001 revenues but posted an operating loss of $2 billion.

Sprint's local division comprises local phone companies serving 8 million mostly rural customers in 18 states across the U.S. It contributed $6.2 billion in revenues and operating income profits of $1.8 billion in 2001. The third division runs Sprint's phone-directory business. It garnered revenues of $1.78 billion and operating income of $264 million.

CASH STASH. The other main unit is Sprint PCS Group (PCS), which holds the company's wireless assets. With 2001 revenues of $9.7 billion and operating losses of $647 million, the PCS Unit is traded under a separate tracking stock. But it's run by the same board and is essentially an integrated part of the entire company, with no operational differentiation, according to Sprint's own annual reports.

In the first quarter of 2002, Sprint turned in a solid overall performance. Only the long-distance business posted an operating loss, while net operating revenues increased for wireless to $2.8 billion, from $2 billion in the same quarter a year ago.

That tracks with Sprint's plan to have wireless drive growth. "With the exception of global markets, the other businesses did pretty well in the first quarter of this year relative to last year," says Peter Cohan, an investment analyst based in Marlboro, Mass. Cohan notes that Sprint managed to slash capital spending and conserve cash. Indeed, Esrey has put together a $2.2 billion cash kitty for a rainy day.

WIRELESS DISCONNECT. Still, that doesn't erase some of the big problems Sprint faces. For starters is the slowing wireless growth. Some analysts think the U.S. market is approaching saturation much faster than Sprint and others anticipated.

When Sprint announced in early June that it would miss its subscriber growth target of 3 million new customers in 2002 by 10% to 15%, alarm bells went off. And noted bear David Tice, of David W. Tice & Associates, seemed prescient for a negative report on Sprint PCS filed in January. The report questioned the long-term economic viability of the wireless unit. Besides lackluster growth rates, Tice worried that acquiring subscribers is becoming even more expensive.

The shortfall in adding subscribers is particularly bad news, given Sprint's reliance on wireless as its growth engine. Equally troubling is the quality of the new subscribers Sprint has added. In 2001, it started trying to lure less credit-worthy customers. The move pumped up subscriber additions, but it could have a heavy cost later on, if customer defaults hammer the bottom line.

NO PRESENCE. Then there's the broadband conundrum. In late 2001, Sprint unplugged its ION broadband effort after losses of $1 billion. ION was aimed at giving Sprint the capability of providing broadband to businesses around the country. But building the network proved to be a major cash drain.

Bailing out of broadband has left Sprint without a presence in the one telecom sector that has managed to boost prices and therefore margins. Sprint is rumored to have struck a deal with DSL provider Covad Communications (COVD) to fill that gap. That could help, but it would still leave Sprint at the mercy of the Baby Bells, which ultimately control the circuits that Covad rents to provide its service.

Sprint is certainly on much sounder economic footing than many companies. But the lingering doubts about its ability to grow quickly and enhance its profitability might give investors pause if they figure on bottom-fishing for some Sprint stock. With reporting by Roger Crockett in Chicago

Salkever is Technology editor for BusinessWeek Online

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