For a blink of an eye, bond investors understood the risks that they were taking with Sprint.
Unfortunately, they appear to have shed some of that skepticism and are no longer fully pricing in the danger surrounding the struggling mobile phone carrier, which has been burning cash for years and is projected to continue doing so.
The company's debt problems are no secret. Out of 70 large U.S. telecom and tech hardware companies, only seven of them top Sprint's net debt of 4.3 times its adjusted earnings before interest, taxes, depreciation and amortization in the prior 12 months, according to an analysis of Bloomberg data.
Investors worried about Sprint's ability to withstand this debt burden pushed down prices for its bonds in the wake of a multistep downgrade in September. But its bonds have recovered some of the decline with about an 8 percent gain since the end of January.
Bond investors who pulled back from the brink of worry may want to think again. In reality, Sprint's reported debt burden may actually understate its precarious position.
The debt on the balance sheets for Sprint and other telecom companies doesn't factor in a looming change to U.S. accounting rules that will force companies to include expenses for operating leases -- such as those for cellphone wireless towers -- on their balance sheets. Adding in the present value of those operating leases, plus a sprinkle of pension obligations and related items, pushes up Sprint's total debt to $50.9 billion from $34 billion, according to an analysis last week by Craig Moffett of research firm MoffettNathanson.
While the rule change doesn't kick in until 2019, it's not as if the financial obligation for those leases will change suddenly at the wave of an accountant's wand. Sprint has already been contractually obligated to pay for its wireless towers, which makes those lease payments Sprint's hidden debt bomb. They've been there all along, but in footnotes and not counted in most debt calculations.
Moffett also rejiggers Sprint's Ebitda figure to add back the company's payments on those operating leases. The good news is that adds $2.7 billion to Ebitda. But he also subtracts $4.1 billion from a shift in business models in the wireless industry under which more people are paying for new smartphones in monthly installments, rather than in upfront purchases subsidized by their mobile-phone company. Adjusting for both higher-than-reported debt and the net $1.4 billion hit to Ebitda nearly doubles Sprint's leverage to 7.9 times Ebitda from more than four times.
While Sprint's heavy debt burden makes it a special case, it is one of several telecommunications companies (and others) that would have significantly higher leverage ratios under the new accounting treatment than they have now. But at the end of the day, this isn't about a balance sheet leverage ratio. It's about having too much debt and not enough income to pay it off.
Sprint has addressed this by trying to mortgage anything it can to keep paying the bills. The company last week struck a deal to sell networking equipment and lease it back for essentially a two-year loan of $2.2 billion. That may help Sprint in the short run, but it still hasn't gotten close to solving its problems.
Majority owner SoftBank has the resources to back Sprint, but it's not exactly thrilled with its investment and it's easy to see how it could run out of patience. SoftBank boss Masayoshi Son paid $22 billion for control of Sprint in 2013 and regretted the decision once it was clear he wouldn't be allowed to merge his company with rival T-Mobile. Now Son is left with a broken toy he doesn't want but needs billions of dollars to fix. “I’m a busy guy,” Son told the Wall Street Journal for an article last year. “Why should I even concentrate on the U.S. market when the situation does not look good?”
That's not enough of a commitment to inspire confidence that Sprint will be able to pay back what it owes. Don't be surprised if Sprint undergoes another swoon in the near future.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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