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Sprint: A Smart Value Play in Telecom

April 23, 2012 | About:
The Attorney General of New York has filed a tax fraud lawsuit against Sprint Nextel (S) accusing the wireless company of deliberately underpaying sales taxes for a period of seven years. According to the Attorney General, the company stopped collecting and paying sales taxes on around a quarter of its revenue from its fixed-price monthly plans for subscribers since 2005. He further alleged that this was done to obtain a price advantage over its competitors such as AT&T (T) and Verizon (VZ) who have collected the taxes that Sprint is accused of neglecting. He says that the unlawful action of the company has cost the state more than $30,000 daily or a total of about $100 million over this period.

Under New York state law, Sprint could be liable for as much as $300 million in addition to penalties. Sprint has categorically denied the allegations and said that the lawsuit is completely without merit. Sprint shares dropped by 5% on the announcement.

Interestingly enough, this is the first lawsuit filed under the New York False Claims Act which allows prosecutors as well as whistleblowers to proceed with legal action against companies accused of defrauding the government. It also requires offenders to pay three times the tax underpayment and whistleblowers are entitled to 25% off any cash that the government receives.

Such a payment could be quite a problem for Sprint who announced losses of nearly $3 billion for the previous year. Though, technically, customers could be liable for the underpayment, the Attorney General has announced that he intends to make the company pay, which is why he is asking for Sprint's current customers in New York State to terminate contracts early without the payment of any fees. I consider this a good time to completely reevaluate investments in Sprint. Unfortunately, the number of adverse circumstances means that the company could be slipping deeper into trouble.

Another problem area that seems to be surfacing is connected with the iPhone. In order to gain economies of scale, Sprint was forced to buy iPhones in large quantities and instead of boosting revenues, this has caused further losses. The related problem is that the company would have to sell its inventory before new models make it obsolete or swallow further losses on obsolete or unfashionable phones. Moreover, the tax problems that have now surfaced is a reflection of Sprint's increasing financial problems because, if it were true, I would consider it extremely unlikely that any reasonably profitable company would stoop to these kinds of tactics. You must keep in mind that Sprint has not been a profitable company since the year 2006 and operating profit last year was barely breakeven.

The company still has over $5 billion in cash and equivalents but its other metrics have been steadily deteriorating. The cash holding amounts to only a quarter of its long-term debt and its debt to assets ratio is at almost 50%. It is exceedingly unlikely that the company could be rescued by a potential acquirer after the regulatory problems associated with the attempted acquisition of T-Mobile by AT&T which was the last major transaction in the telecommunications space. Unfortunately, spectrum is a highly overrated asset and the entire hullabaloo about it being a limited resource is misplaced. After all, technology has consistently proved that it is capable of overcoming any restrictions on spectrum. As a result, the liquidation value of Sprint is anybody's guess but it is unlikely that the assets including spectrum are going to fetch a decent price.

It is also time to look at what the competition is doing especially where 4G, which is touted as being the new best thing in the telecommunication industry, is concerned. At first sight, Sprint's strategy looks impeccable because it is planning to bypass the auction of airwaves completely by changing its proprietary iDEN spectrum for use on the new platform. The specific plan is for Sprint to transform its Nextel iDEN push-to-talk infrastructure for use by LTE 4G hardware and use the 800 MHz spectrum that is freed up to boost the growth of 40 services. This leads both AT&T and Verizon to fight over the spectrum that would be available at the next auction.

The financial and operational performance of Verizon suggests that it would be the favorite in such a battle. AT&T has possible funding constraints because of the large amounts of capital that are already tied up along with union issues such as pensions and health care. It is also committed to large marketing expenditures to promote the new Nokia Lumia 900 phone. The benefits of Sprint's bold and courageous strategy would be cost-effective and competitive in terms of 4G service quality besides conserving billions of dollars on possible airwave purchases. Besides, Sprint has already announced a couple of new handsets for the new 4G services in the HTC EVO 4G LTE as well as LG’s eco-friendly Viper handset. The HTC phone claims to be the first HD voice enabled phone to become available with a dramatic improvement in the quality of the sound. The Viper provides quite a package of features and services at an extremely affordable price.

Sprint is the little brother of the large telecom players and will continue to be so for quite a long time. The 4G LTE opportunity may well give the company a chance to break out of its loss-making rut and, to some extent, reduce its dependence on Apple (AAPL). If you were an existing investor in Sprint, I wouldn't panic, but continue to hold the stock and watch for future developments. There is little downside in holding on to the investment though this will, to some extent, depend on how the sales tax lawsuit plays out. In fact, if the stock price drops any further, you should seriously consider buying some more stock.

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