Wednesday, May 05, 2010

Sprint Nextel (NYSE:S): Upgrading to BUY from HOLD and Raising PT to $6.00 - Deutsche Bank

Deutsche Bank is upgrading Sprint Nextel (NYSE:S) to Buy from Hold and are raising their price target to $6 (prev. $4.75)

According to the firm, the upgrade is based on 2 related factors:

1) They expect continued stabilization in operating fundamentals, driven by improved trends within Sprint's post paid wireless business. For example, Sprint has now reported three consecutive quarters of YoY growth in post paid gross adds and was the only Big 4 carrier to report YoY share gains in 1Q. This trend supports Deutsche's expectation that Sprint is poised to report net growth in its core CDMA post paid subscriber base in 2H as the company launches new 3G/4G devices and 4G markets. Based on these trends, they believe that wireless service revenues will return to growth by 2H10 and that wireless EBITDA margins have effectively bottomed with QoQ trends primarily driven by normal seasonal factors and not top line pressures.

Forecasts Suggest Conservatism: Deutsche is assuming that Sprint’s wireless service revenue and EBITDA margins bottom in 2010 and then begin showing modest growth in 2011. In their view, this is a conservative outlook based on the company’s trend lines into 2H10.

Based on the stabilizing trends that they have seen, and expect to continue seeing, from Sprint, the firm believes that the long period of sustained downward revisions to consensus EBITDA estimates is in Sprint’s past. In firm's view, this is a meaningful evolution as they believe Sprint’s valuation has remained compressed based on a combination of weak fundamentals and weak confidence in the company’s outlook.

The figure (10) highlights why investor confidence in Sprint’s outlook has been so weak. As shown, the company has experienced substantial downward revisions to forward year- EBITDA estimates. For example, during the 12 quarters prior to the ends of 2009 and 2010 consensus EBITDA estimates declined by >50% for both years. Based on these severe reductions to Street forecasts, it is easy to understand why Sprint has been trading at a valuation discount vs. its peers.

But, confidence already seems to be improving. For example, we are currently 7 quarters away from year-end 2011 and the consensus 2011 EBITDA estimate has declined only 7% since the start of 2009. Looking at the comparable periods one year ago for 2010 and two years ago for 2009, the estimate reductions at this point were 45% and 48%, respectively. Based on the traction they are seeing within Sprint’s post paid business, Deutsche believes that 2011 EBITDA estimates might actually begin to trend higher from this point, which could be a positive valuation catalyst for the stock as it would reflect a complete reversal in sentiment.

2) Valuation does not seem to reflect an improving fundamental story. For example, Sprint is trading at 4.1x 2010E EBITDA vs. 4.9x for AT&T, 5.3x for Verizon, 5.1x for MetroPCS and 6.3x for Leap Wireless. In other words, the stock is trading at a minimum ~1x discount to its peers. While this valuation gap seemed reasonable when the company was experiencing annual declines in revenue of 10-11% and EBITDA of 15-30%, they believe that the company’s now stabilizing fundamental trends warrant a revaluation of the shares. Deutsche estimates that this ~1x EBITDA discount equates to $1.90/share of equity value implying a nearly 50% valuation gap vs. the lower-end of Sprint’s peer group.

New Price Target Looks Conservative on a Sum-of-the-Parts Basis
Based on these factors, Deutsche is resetting their price target to $6.00 based on a targeted valuation 5.25x 2011E EBITDA, which is an increase from their prior target of 4.25x. The adjustment primarily reflects their view that Sprint’s valuation gap vs. its peers will close as operating fundamentals show further improvement. It is also supported by a sum-of-the-parts analysis, which looks at Sprint’s valuation based on peer group EV/sub valuations. This analysis suggest a low-end valuation of $6/share even if they value Sprint’s post paid subs at only 25-50% of the implied valuations at AT&T and Verizon and assume that its prepaid subs are no better than those at prepaid operators such as Leap Wireless and MetroPCS.

Notablecalls: The sentiment in Sprint (S) has improved markedly over the past months & the stock has reacted rather well to positive analyst commentary. RBC Capital upgraded the name to an Outperform last week and the stock was up ~5% in reaction. And I mind you, unlike Deutsche, RBC is no tier-1 firm.

So, today Deutsche is upgrading Sprint as they think the EBITDA declines are pretty much done and we may even see #'s up y/y in the second half of 2010. That should help the valuation in a fairly meaningful way as Sprint is no longer considered to be in terminal decline.

Deutsche highlights some n-t positive catalysts - the launch of HTC EVO, Sprint's first 4G handset, by mid-year & a possible strategic partner for Clearwire.

Check out the HTC EVO, huge screen, lots of computing power (1Gh Snapdragon) & it will run on Android OS. A really neat phone that should attract some additional subs.

Anyway, I think S will trade higher today, likely by at least 5% and possibly by 6-7% if the general market plays ball.

So 4.30-4.40 is the range I'm looking for here. Let's see how it works out.

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