Is Sprint Poised to Make a Strategic Misstep under New CEO? FBR Capital Markets

Posted on behalf of David Dixon, FBR Capital Markets

Sprint CEO Marcello Claure has undertaken a strategic review of Sprint’s competitive positioning according to our vendor checks. Claure is an entrepreneur who seeks to move quickly to reposition the company. While he is not a network engineer, he understands that the network is a strategic asset and is seeking approval to undertake a major network investment program, which we believe is approximately $25 billion over the next five years, and could realign the company with Ericsson. The challenge is the deteriorating FCF position of the company and a desire to achieve FCF positive status. This suggests a materially lower annual capex spending program of $3 billion is warranted, but at this level, Sprint is at risk of under-investing and at risk of weakening its franchise value further unless the company embraces a technological shift that is underway. Recall that management is expected to provide full calendar-year 2015 capex during the next earnings call. This will be shaped by the company’s strategic decision on its network strategy.

Mr. Claure has brought in Truco as his strategic Network Advisors led by trusted friend Sol Trujillo. Claure and Trujillo developed a solid, trusted relationship while Claure was at Brightstar and Trujillo led Telstra (he was formerly head of US West). However, this strategic advisory group is advocating a premature network rip and replace programsimilar to what was undertaken under Network Vision and similar to what has recently been undertakenby CSL Limited in Hong Kong. The question for investors is whether CEO Claure can be convinced to makethe right decision for Sprint investors at this juncture ahead of a major industry technology shift.

At this stage it appears he may be too reliant on the Truco advisory group which many believe are backward network engineering thinkers, trying to convince the company to adopt the second (high cost high risk)strategic approach described below. This would be an unfortunate misstep and a missed opportunityto embrace the technology shift underway in our view.Improving indoor and outdoor coverage and capacity is a major strategic challengefor Sprint.Coverage capex is expensive while Sprint can manage data usage growth within its existing footprintvery cheaply with aggressive 2.5GHz deployments on the macro network.

We see three strategies open to Sprint to improve coverage and progressively deploy VoLTE (an IP based LTE application that would allow the company to wind down its CDMA footprint and re-farm spectrum for LTE):

(1) Add macro cell sites.

Management could agree to add more macro cell sites (approximately 10,000)– The cost is high at approximately $3 billion capex and higher opex due to higher backhaul and siterental expenses. Furthermore, the time to deploy is long – up to 18 months to get a site underway.Network Vision proved this cannot be done quickly. For this reason the best macro site based coverageimprovement strategy was through M&A with T Mobile to create a bona fide healthy third operator thatcould better compete with AT&T and Verizon with dramatically improved consistency of service through a densified network grid of cell sites that could also facilitate the elimination of the CDMA networkthrough an accelerated refarming strategy similar to the advantage that AT&T and Verizon have todayin this regard.

(2) Convert its 1.9GHZ spectrum to uplink.

Management could improve coverage by converting 1.9GHz spectrum to uplink (FD LTE) and aggregate the 1.9GHz downlink spectrum with 2.5GHz downlink. Thisis Ericsson’s preferred approach in our view that fits neatly with its challenge in being behind theindustry in TD LTE yet needing to re establish a 4G relationship with Sprint and cement is networkterritory. Under this strategy there is significant deployment risk. For example, Sprint needs to ripand replace the baseband unit (BBU) at each site which is premature in our view. While this is aneasier undertaking relative to a site rip and replace, there is still significant interoperability testing (IOT) network optimization and development issues to address.

The Network vision program highlighted significant deployment issues and nothing has improved in the E&C industry to suggest Sprint could successfully complete a major rip and replace project. In fact the environment has worsened. For example, Ericsson acknowledges it had twice the size of the team they have now. Previously, higher capex spending drove a healthy ecosystem and the industry had a lot more incentive to commit to Sprint.

Bottom line, if pursuing this path, management would need to be more pragmatic about the upgradetimeline of three to five years. We believe CEO Claure favors this strategy but this plays into the hands of Ericsson which was rejected by China Mobile as a TD LTE vendor and had to fire most of its engineeringbase in this area as a result. TD LTE is an industry trend and we believe this option is a backward stepfor the company ahead of a major technology shift that is underway across the industry to embrace lowcost LTE overlay networks using low cost small cells on dedicated spectrum bands.

(3) Focus on indoor small cells on dedicated 2.5GHz spectrum to improve coverage and achieve more offload.

In our view this is the lowest risk and lowest cost strategy for the company. The use of adedicated spectrum band, (i.e. inside LTE Band 41 – 2.5GHz spectrum) to create an LTE overlay networkis the industr

ZTE, Huawei and NSN (now 100% owned by Nokia) are key vendors and trials are occurring this year ahead of commercial deployment in 2017.  NSN is moving ahead nicely and both NSN and Alcatelhave received official requests from China Mobile so they will have to make TD LTE and massive MIMO a reality in 3 years so the question is why proceed with a high risk rip and replacement of the network prematurely with high deployment risk.

Recall that management is expected to provide full calendar-year 2015 capex during the next earningscall. This will be shaped by the company’s strategic decision on its network strategy and could rangefrom $3 billion to $5.5 billion in our view as a result. 

Note: IEEE ComSoc is grateful that FBR Capital Markets permits us to share it’s very incisive telco research at this web site.  Special thanks and acknowlegement to David Dixon, the author of the above post.