Cricket-parent Leap Wireless (Nasdaq: LEAP ) has been on a tear lately. The stock has about doubled since the market bottom in the beginning of October and has reached its highest price since August. Shares jumped more than 10% yesterday as rival MetroPCS (NYSE: PCS ) beat Wall Street estimates in its fourth-quarter report with EPS of $0.25, crushing estimates of $0.16. The strong quarter sent its stock price up nearly 14%. Shares of Sprint Nextel (NYSE: S ) and Clearwire (Nasdaq: CLWR ) also soared, up 13% and 7% respectively on news that rival T-Mobile had lost over 800,000 contract subscribers in its fourth quarter largely because it's now the only national provider not offering the iPhone.
While MetroPCS certainly deserved an ovation for topping earnings estimates, it's odd to see that effect carry over to the Cricket purveyor. It's not as if investors are still waiting on its Q4 results. Leap's disappointing earnings came out last week, sending shares down nearly 3%, making yesterday's bump seem undeserved.
Still playing catch-up
The two companies bear many similarities as the largest unique providers in the domestic prepaid wireless market, but while MetroPCS has been consistently making money, Leap has gone four years since its last profitable quarter.
Financially, the commonalities continue. Both carry heavy debt loads, and similar gross margins of roughly 41%. But a closer look at the Q4 numbers reveals some key differences holding Leap back, as the chart below shows:
Selling, General, and Administrative Expenses
Depreciation and Amortization
Cost per Gross Addition
Source: Company reports. All numbers (except cost per gross addition) in thousands.
Despite sales 38% below MetroPCS', Leap still spends more money in the two fixed-cost categories above, and takes on greater interest expense from paying a higher interest rate.
Sales, general, and administrative expenses are important to track because they show how efficiently a company is using its management and marketing dollars. Similarly, though depreciation and amortization aren't cash charges, they're representative of how wisely a company uses its fixed assets.
As a percentage, Leap spends almost double what MetroPCS pays for SG&A. It's no surprise then to see MetroPCS' cost to add new subscribers is almost a third below Leap's. This is a key metric for subscription-based models. Adding new users needs to be affordable in order for the business to grow, and an increasing cost per gross addition shows that the company is struggling to find new users, having already signed the low-hanging fruit. Leap's Q4 cost per gross addition rose to $238 from $209 a year ago.
The buyout option
A day before Leap's earnings release last week, another piece of news about a rival sent its shares soaring. The Wall Street Journal reported that AT&T (NYSE: T ) was looking to acquire more spectrum in the wake of its failed merger with T-Mobile, and that Leap was a top target. According to JP Morgan Chase analysts, the spectrum could be worth $2.1 billion, about 2.5 times Leap's market value.
Though an acquisition would certainly reward Leap shareholders, the buyer would find itself with more than $3 billiion in additional debt as part of the price for increasingly scarce wireless spectrum.
Notwithstanding a takeover, Leap will need a dramatic subscriber increase to push it into profitability. The company makes approximately $20 in gross profit per month per subscriber. Assuming that margin continues along with present fixed costs and interest expenses, the company would need to add about 1.3 million subscribers to its current total of 5.9 million to break even. Having added just 415,000 net subscribers in 2011 and 179,000 in the fourth quarter, Leap figures not to cross this threshold until 2013 at the earliest, and the maturation of the domestic wireless market won't help. Still, higher-revenue pay plans from smartphones could buoy the company, but I'm not betting on the low-price provider returning to profitability. Investors better hope Ma Bell doesn't drop the call.
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