Though Sprint's (NYSE:S) commercials for its new Framily plan have caught customers' attention, the company is fighting a losing battle. In the wireless industry, Verizon (NYSE: VZ) and AT&T (NYSE: T) are crushing this company, and no amount of talk, plans, or changes will alter that.
The company just doesn't get it
One of the most important factors in choosing a wireless carrier is call quality. While it's true that many people use their cell phone for much more than phone calls, the cell phone is also becoming the new "home phone." Across the telecom industry, customers are canceling their landlines in favor of cell phones.
It's true that Sprint has been expanding and improving its network, but this actually is part of the problem. The company specifically said that part of the reason its postpaid churn was higher in the current quarter was due to "elevated churn related to service disruption from the network overhaul."
Sprint has put itself in a catch-22 situation. The company's postpaid churn of 2.1% was almost double the churn at AT&T and Verizon, which were both at just more than 1%. Sprint has roughly 70% less postpaid subscribers than Verizon, and 59% less than AT&T. Given that the company has far less subscribers and double the rate of churn, Sprint's Framily is shrinking.
This shouldn't surprise anyone
While the Framily plan may be a great value for customers, the fact that millions of people are moving to this plan could be very bad news for Sprint shareholders. It's a big mistake for investors to assume that what is good for customers is good for shareholders.
In a traditional wireless plan from either AT&T or Verizon, customers might pay as much as $40 a month for use of their smartphone along with possibly $40 a month for a data plan. Framily offers the ability to spend as little as $25 a month for the same effective usage.
This lower monthly cost -- and the fact that Sprint gets a significant portion of its subscribers from prepaid plans -- presents a challenge to the company's margins. Comparing the big three's operating margins shows how significant the difference is between the companies.
Verizon leads the wireless pack with an operating margin of 35%. AT&T sports an equally impressive margin of over 28%, whereas Sprint's margin of less than 5% should make investors question the wisdom of joining the Framily.
Things are about to get much worse
In the current quarter, Sprint generated $89 million in core free cash flow -- net income plus depreciation, minus capital expenditures. Some investors might look at this as a huge win for the company and be encouraged for Sprint's future results. However, the company has laid out a roadmap for spending that suggests the company's cash flow is going to get much worse.
We know that Sprint has far less postpaid subscribers than its peers, and this is bad enough. But the comparison gets downright ugly when we look at free cash flow. In the last three months, Verizon generated $6 billion in core free cash flow, and AT&T generated just less than $3 billion. By comparison, Sprint's free cash flow looks anemic.
The bad news is, Sprint suggested that CapEx for 2014 should come in at around $8 billion. In the first quarter, the company spent just more than $1 billion. This means Sprint will spend about $2.3 billion on CapEx each of the next three quarters. Unless Sprint generates significantly more operating cash flow, this type of spending next quarter might leave the company with negative free cash flow of at least $1 billion.
The bottom line
With its competitors growing their wireless businesses and Sprint showing a decline in subscribers, things aren't getting better. A ridiculously low margin is part of why the company's cash flow has such challenges. With higher capital spending potentially leading to billions in negative free cash flow, it's possible that Sprint's Framily of investors are in for more pain than gain.
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.