At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
And speaking of the worst...
On a miserable day for the markets Friday, at least some investors got good news, when Sprint Nextel (NYSE: S ) shareholders received word of an upgrade from JPMorgan. Citing a series of factors working in Sprint's favor, the international megabanker upgraded Sprint shares from neutral to overweight.
Why? According to JP, Sprint is making good progress with its launch of LTE, fourth-generation cellular capability, and plans to expand to six more cities by "mid-2012." (Isn't it already mid-2012)? The company's also pushed through a $10 monthly fee increase on its all-you-can-eat data plan for smartphones. (That happened last year.) Based on these projections, JP sees Sprint booking about $35 billion in revenue this year, and earning just over $3.9 billion in earnings before interest, taxes, depreciation, and amortization, or EBITDA.
Here be dragons
But that's just the thing. What worries me about Sprint isn't its earnings... BITDA. It's the "BITDA" part itself that concerns me. Look past JP's happy talk, and the facts surrounding Sprint look quite a bit grimmer than JP suggests. For example, Sprint labors under a massive debt load of $14.7 billion (net of cash), or nearly twice its own market cap. This adds up to more than $1 billion in interest charges Sprint must pay, even with today’s ultra-low interest rate environment.
Depreciation and amortization charges are even more significant (more than $4 billion a year). Combined, "BITDA" costs are keeping Sprint from earning any net profits today. Indeed, most analysts will tell you they foresee little chance of Sprint breaking even before 2015. Meanwhile, JP itself admits that ARPU, or average revenue per user, is low at Sprint, even after the hike in data plan rates.
Is Sprint as bad as it looks, or as good as JPMorgan makes it sound?
I don't mean to sound all doomy and gloomy about Sprint. The company's not all bad. For example, while net profits have gone missing (along with the dividend), Sprint does generate free cash flow (albeit not at the levels of years past). Despite continued cash infusions to the black-hole money pit that is Sprint partner Clearwire (Nasdaq: CLWR ) , Sprint's own free cash flow over the past 12 months still amounted to $481 million.
The problem, though, is that once you factor Sprint's massive debt load into the picture, this results in an enterprise-value-to-free-cash-flow ratio of more than 46 times on Sprint stock. By way of comparison, rival AT&T (NYSE: T ) costs only about 18 times free cash flow, while Verizon (NYSE: VZ ) sells for the comparatively modest sum of 14 times FCF.
More happy talk from JP
Speaking of which, the final reason JPMorgan believes Sprint will surprise us is because "a modest glut of facilities-based carriers and an untold number of off-brand virtual operators in the market" will give way to consolidation in the industry. If JP's right, this would reduce competition among the remaining players, and give greater pricing power to all of them -- Sprint included.
To which my only response can be: "Is JPMorgan serious? Do these guys even read the papers?" I mean, the U.S. government just finished stomping all over the last big telco consolidation move, when it quashed AT&T's attempt to merge with T-Mobile. And considering how big the major players -- Verizon, AT&T, T-Mobile, and Sprint -- are today, it's hard to see feds allowing any other big merger ideas among the survivors. Meanwhile, mergers with smaller players seem unlikely to move the needle much for anybody.
On the contrary, those smaller players appear to be ramping up the competition, as we saw last week with Leap Wireless' (Nasdaq: LEAP ) decision to market a prepaid iPhone. This bodes ill for Sprint, which bet big on the iPhone last year, and now faces a small-fry trying to undercut it on price and convenience.
Foolish final thought
Long story short, with too much debt and too high a share price, no earnings and weak free cash flow, Sprint has its work cut out for it if it's to prove JPMorgan right.
Could it succeed? Could JPMorgan be right to recommend the stock? I honestly don't think so -- partly because the numbers just don't work for me, and partly because JPMorgan itself has a record of only getting it right on its telecom stock picks about 33% of the time. (To see how we came to this conclusion, click here to see a detailed rundown of JPMorgan's record.)
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