Sprint Makes Progress, But Not Much

While Sprint Nextel's earnings show hopeful signs, those signs might be misleading. And investors have yet to be convinced

Sprint CEO Daniel R. Hesse
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In recent months, Sprint Nextel (S) has been described as "seen turning a corner" by The New York Times and as possibly "turning around" by The Washington Post. That's not quite how Sprint CEO Daniel Hesse sees it. While he says he is very pleased with the company's progress, he told BusinessWeek: "We haven't turned the corner yet." Believe it.

Earnings of the U.S.'s third-largest wireless service provider do show some hopeful signs: Thanks to network improvements and changes Hesse has made to the carrier's billing and customer care, the percentage of postpaid subscribers jumping ship each month—a measure called churn—dropped from 2.45% in the first quarter to 2% in the second quarter. The carrier's average revenue per postpaid subscriber stayed steady instead of declining sequentially. Sprint's revenue per prepaid user rose slightly, and margins improved.

Alas, that's slim consolation. In the second quarter, the company swung to a net loss of $344 million, on sales of $9 billion, from a profit a year ago. Investors sent the shares down 14%, to 7.34, on the news, discerning troubling signs in the company's earnings and outlook. On closer examination, many of its improvements lose some of their luster. Take lower churn, for instance. The drop could partly be seasonal, as subscribers worry about planning vacations rather than seeking out better deals: Sprint reported exactly the same churn rate in the second quarter of 2007, when customer turnover fell to 2%, from 2.3%, in the quarter before. Indeed, on Aug. 6, Sprint forecast higher churn in the third quarter. Plus, don't forget that Sprint's postpaid subscriber base, from which the churn measure is derived, has shrunk from 41.6 million to 38.9 million in the past year.

Sprint's churn decline looks even less impressive when compared with the rest of the wireless industry. Every major carrier's churn has dropped in the second quarter. AT&T's (T) second-quarter postpaid subscriber churn fell from 1.2% to 1.1% sequentially. The wireless industry has matured, and subscribers no longer change service providers as frequently. In that environment, subscriber additions may be a better measure of a company's performance, believes Craig Moffet, an analyst with Bernstein Research—and Sprint's adds are not pretty.

Subscriber Loss Continues

While fewer users left Sprint in the second quarter than many analysts anticipated, the company still lost 901,000 customers, a loss partly offset by a 112,000 gain in prepaid and a 13,000 gain in wholesale and affiliate users. By comparison, AT&T added a net 1.3 million wireless subscribers. While Sprint's losses have slowed sequentially, and are partly due to the company's culling of unprofitable subscribers, the bottom line remains that Sprint is still bleeding subscribers at a head-turning rate. Jim Moorman, an analyst at rating service Standard & Poor's, which, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP), doesn't expect the bleeding to stop for at least a few quarters. "Put simply, Sprint is simply not yet competitive versus AT&T and Verizon," Moffet wrote in his Aug. 6 report.

To combat this problem, Sprint has refocused on retention of existing users vs. the acquisition of new customers. "We now treat existing Sprint customers as the most important visitors to our stores," Hesse said during the call. But will that help? The U.S. economic outlook continues to worsen, and rivals such as AT&T are grabbing users with new devices like Apple's (AAPL) new iPhone. As carriers MetroPCS (PCS) and Leap Wireless (LEAP) expand their coverage nationwide, they could well eat into Sprint's subscribers and revenue per user, says Susan Welsh de Grimaldo, an analyst at Strategy Analytics in Newton Center, Mass. "[Sprint is] trying to turn its ship around, and it's a very large ship," says Moorman. "And you are going against the perfect storm, with the introduction of the iPhone 3G."

To compete with the iPhone, the company may have to increase its subsidies of cool new devices, like its best seller the Samsung Instinct, which could result in higher costs. Phil Asmundson, a vice-chairman at consultancy Deloitte & Touche, says Sprint may want to try differentiating its services by introducing phones that track a person's heart rate, or push more aggressively into mobile payment services, allowing people to use their phones like a credit card. "Those types of things can really get a lot of subscribers," he says.

Web Browsing Lead

Greater focus on data plans and services could help stem losses as well. Already, Sprint leads major U.S. carriers in its customers' use of mobile Web browsing: Nearly 22% of Sprint's users browse the Internet on their mobile phones, vs. 19% for AT&T and 12% for Verizon Wireless (vz/vod) customers, according to consultancy comScore M:Metrics (SCOR). That may give Sprint an edge in expanding its sales of mobile games and other applications and services.

But Sprint may also need to introduce more innovative—and possibly cheaper—voice and data plans to grab users' attention. And that, in turn, raises serious questions about the company's ability to keep its earnings and revenues per user up. Already, the company's third-quarter guidance is tepid: Sprint expects its operating earnings before charges like depreciation to decline, and its average revenue per user to come under pressure through the end of the year. That's in sharp contrast to the rest of the industry, which is benefiting from more users signing up for data plans: Industrywide average revenue per user should rise from $50.14 in 2007 to $50.40 this year, according to Strategy Analytics.

To reflect his concern with the outlook, on Aug. 6, Moorman cut his earnings estimates for Sprint for 2008 and 2009, and revised his target price from $11 to $9. And other analysts question Sprint's ability to continue to generate as much cash. "While the [capital expenditure] reductions enabled Sprint to report positive free cash flow for Q2, the current level of capital spending does not appear sustainable, in our view," said Moffet. "Sprint risks mortgaging its future if it cannot keep pace with network investment."

The bottom line: "We made an awful lot of progress in one quarter, but it's important that the market understand it is long term and not to expect that level of improvement every quarter," Hesse told BusinessWeek.

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