Over the last couple years, Sprint (S) has set its sights on Verizon Communications (VZ -0.68%). It's even gone so far as to steal Verizon's old spokesperson, Paul. Sprint's aggressive pricing has put pressure on Verizon's ability to add new customers and improve its service revenue. But it's also come at the cost of Sprint's own top line.
Sprint's recently failed merger with T-Mobile (TMUS -0.08%) caused both Sprint's and Verizon's shares to fall. Investors may be looking at the price drops as an opportunity to invest -- but in which company?
Let's take a closer look to determine which stock is a better buy: Verizon Communications or Sprint.
Image source: Sprint.
Sprint can't afford to keep up the pressure
Sprint's aggressiveness over the last couple years has been supported by the idea that another company would find its subscriber base attractive and want to buy it out. But after talks with cable companies and T-Mobile failed to result in an acquisition agreement, Sprint is left out in the cold.
With a pile of debt to service and a lagging wireless network, Sprint must focus on growing free cash flow on its own without a suitor to provide a cash infusion or otherwise bolster its network. Sprint has taken steps to inflate cash flow by selling network assets to a sister company, LeaseCo, which uses said assets as collateral to take out loans. Sprint can then use the cash to expand its network and repeat the cycle. But that's not very sustainable; it's just kicking the can down the road.
With a wireless network that consistently ranks at the bottom of the pack, Sprint's main competitive advantage is its pricing. While it's still promising to undercut any of its competitors' prices on devices, it's already taken its foot off the pedal in terms of proactive promotions after lackluster success from its free service offer for new customers. That could mean fewer subscriber additions, leaving more for competitors like Verizon. Overall, however, it should enable Sprint to start showing progress on its bottom line.
Verizon is turning things around
After a couple years of disappointing net subscriber additions, Verizon has shown signs of life following the launch of its unlimited data plan. Verizon's postpaid phone subscriber additions in the first two quarters following the launch have been better than expected, with 358,000 and 274,000 net additions in the second and third quarters, respectively.
Meanwhile, service revenue is starting to show signs of life. The line item increased sequentially in the third quarter after 11 straight quarters of declines. Verizon expects to see further improvement in the fourth quarter, and it should start showing year-over-year improvements next year. The increased revenue should result in better profit margin for the wireless segment, which makes up the majority of Verizon's business.
A reduction in competitive promotions from Sprint and T-Mobile would greatly benefit Verizon, which has been one of the biggest losers from the cutthroat actions of the two smaller carriers. Just as Verizon is showing signs of life, it could get a big boost from a less competitive environment going forward.
A look at valuation
While Verizon is moving in the right direction and Sprint is in a precarious position, valuation is still an important factor to consider in any investment decision.
Verizon currently trades at about 6.7 times its EBITDA. That's a significant premium to Sprint's 5.2 multiple.
But consider that Sprint carries a large amount of device leases on its balance sheet, providing a large group of depreciating assets. Year to date, Sprint has depreciated $1.7 billion in leased devices. In the last six months of fiscal 2016, it deprecated $3.1 billion. Discounting the impact from leases, Sprint's enterprise value-to-EBITDA ratio is more like 9.4.
In that light, Verizon looks like a much better value. With service revenue headed in the right direction, profit margin expanding, and more subscribers signing up, it should produce solid returns for investors. Not to mention it pays a hefty dividend (Sprint doesn't pay one at all).
Verizon is a better buy than Sprint for investors interested in the telecom industry.
