Sometimes an Underdog Deserves to Be Put Out of Its Misery

Betting on an underdog sometimes can provide a huge gain. However, sometimes an underdog is that for a very good reason and deserves to be put down.

Feb 24, 2014 at 7:00PM

So, you're thinking about buying an underdog, looking for a big gain. You keep telling yourself, "it can't go any lower" or "if it goes up just $2, I can make 25%." You can almost feel these types of thoughts from shareholders of Sprint (NYSE:S).

The bad news is, sometimes an underdog deserves to be put down. In fact, there are at least three reasons why Sprint may not come back.

Wire-less for sure
Of the three largest carriers; Sprint, AT&T (NYSE:T), and Verizon (NYSE:VZ), Sprint is the only one to report net losses of postpaid subscribers last year. Let that sink in for a minute.

Sprint may boast nearly 54 million subscribers, but just under 31 million are postpaid. The remainder are a combination of prepaid and wholesale customers. The reason postpaid subscribers are important is, their average revenue per account is more than double that of prepaid customers.

Considering that Sprint only added 58,000 postpaid subscribers last quarter, this is cause for concern. However, when you compare this with the 566,000 postpaid additions at AT&T or the 1.6 million postpaid additions at Verizon, it looks much worse.

It's true that both AT&T and Verizon boast much larger subscriber bases than Sprint, but that's the point. If you are in third place and you only add a few new subscribers, how do you plan to compete with the big boys? Given that Sprint gets about 80% of its wireless revenue from postpaid subscribers, adding fewer subscribers than its peers is just the first big problem facing the company.

This should churn your stomach
Clearly, Sprint has an issue when it comes to growing its postpaid subscriber base, but the company's churn rate is an even bigger problem. In the simplest sense, the higher a company's churn rate, the harder it is to grow its user base.

In the current quarter, Sprint reported a postpaid churn rate of 2.15%. By comparison, AT&T's churn rate was just 1.1% and Verizon's churn rate came in at 0.96%. If all three companies had the exact same number of subscribers, Sprint would lose almost double the number of subscribers as AT&T and more than double that of Verizon.

Considering Sprint already has less postpaid subscribers, a churn rate that is much higher than its peers is a huge problem.

Remember when Softbank was supposed to solve everything?
When Softbank took a multi-billion dollar stake in Sprint, some suggested this was the end of Sprint's financial woes. The international company would give Sprint enough money to compete more effectively with the likes of AT&T and Verizon, and a strong third wireless carrier would emerge.

But that's not what happened. Sprint hasn't been able to generate consistent positive free cash flow, and carries about $25 billion in long-term debt. If you expect the company to turn cash flow positive anytime soon, think again.

In the current quarter, Sprint generated $843 million in negative core-free cash flow (net income + depreciation-capital expenditures). Consider that in the last year, AT&T and Verizon generated over $16 billion and $23 billion in core-free cash flow respectively.

What's extremely disturbing is Sprint is forecasting an $8 billion capital expenditure budget for 2014. In the last three months, the company spent about $1.7 billion in capex, so the budget suggests an increase.

The third major issue facing Sprint is its operating income will have to more than double, to meet the company's interest expense on a quarterly basis. With AT&T and Verizon spending less than 12% of their operating income on interest, there is a cavernous difference between the three companies.

To make a long story short
The bottom line is, Sprint has a huge pile of debt; it isn't growing its most profitable subscribers; and it has a churn rate that is nearly double the competition. Sprint isn't just an underdog, I think it's a dying company and deserves to be put down.

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Chad Henage owns shares of Verizon Communications. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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