Sprint’s turnaround story continues with another quarter of positive postpaid net add growth and historically low churn. We believe recent pricing action, coupled with evidence of broader network improvements, bodes well. Positive subscriber momentum confirms that Sprint’s turnaround is beginning to gain traction.  

We are encouraged that roughly the majority of Sprint’s customer base is using tri band devices. Sprint achieved positive net adds with its aggressive 50%-off offer despite recent price increases (unlimited data plan increased to $70/month from $60/ month). This offer appears to be accretive, as many customers are buying additional data for a similar price they paid to Verizon and AT&T.

Lack of Free Cash Flow continues to drive the network strategy, which is getting underway at a lower cost trajectory than expected by the market; Sprint provided more details around the new device lease facility in partnership with SoftBank.

Looking ahead, we see an improved liquidity position as Sprint extends its leasing focus to the financing of cell site installation and equipment on more favorable terms than Sprint’s current, unsecured, high-yield bond rate, which should further improve Sprint’s cost structure.

Key Points:

■ Management raised FY15 and FY16 adjusted EBITDA guidance. As a result of cost savings and revenue growth, the adjusted EBITDA trajectory is improving faster than expected. Management raised fiscal-2015 adjusted EBITDA guidance to $7.7B–$8B. Its preliminary estimate for fiscal-2016 adjusted EBITDA is in the range of $9.5B–$10B, substantially higher than consensus estimates. We are confident management can drive out further network head-count costs as it leans on Google to assist with network planning and backhauls traffic inside 2.5 GHz, instead of through leased fiber backhaul.

■ Network update. Performance is benefiting from optimized NV markets. Planning for the small cell pivot is underway, but equipment orders remain light. The initial focus is outdoor urban, where there is no WiFi option, so customer churn risk is highest and roaming expense can be minimized. The major risk is that Mobilitie, the network financing installation partner, promises Sprint the world at one-third of the cost, gets early wins on easy site locations, but does not get the key sites where Google tells Sprint it needs them. Mobilitie may have to fail before vendors help. This will become clearer by the end of 1Q16.

Sprint Network Performance Improving Due to Network Vision Optimization

Independent network checks and Sprint reseller checks confirm improving network coverage relative to T Mobile US and Sprint is closing the gap with AT&T and Verizon. However relative performance metrics are already declining in Chicago because the company spent too long messing around with the wrong network strategy. Management now appears to be on the right path and should be able to add capacity quickly and cheaply as long as they continue to hold Mobilitie’s feet to the fire. Mobilitie should have good early successes but the key will be its success in the harder to locate but most important dense urban areas in major cities.

LTE is available in all markets and the LTE plus network (i.e. Carrier aggregation 2 x 20MHz of 2.5GHz) is now in 150 markets. Downlink cell edge performance is 10x faster when the company adds 2.5GHz to a 1.9GHz cell site. While there is no change to the uplink performance (due to 2.5GHz having weaker propagation than 1.9GHz) the downlink is served by the wider, high power downlink channel increasing cell edge speed from 500kbps to 5Mbps based on our checks. The company noted peak speeds of 100Mbps are possible and is marketing on this basis. The question is how sustainable can this improved performance be. We believe 2.5GHz is the key to sustainability. Adding capacity is cheap if you have spectrum. The percentage of time customers are on the LTE network at 94% is also very encouraging with respect to VoLTE.

In our view, to achieve network superiority relative to Verizon and AT&T, Sprint will need to establish greater network consistency. This is not possible, in our view, without the consolidation with TMobile, as the company does not have sufficient cash flow to invest in high-cost network coverage in the near to medium term. We believe senior management understands that establishing network superiority in two years will be very difficult (perhaps five years is more realistic) but continues to drive at this lofty goal.

The concern is execution. Engineers are incented to take short cuts on vendor interoperability due to this aggressive target. However 2.5GHz is the jewel in the crown and the company has a terrific head start on the competition which is looking forward to the 3.5GHz band to provide it with a similar low cost spectrum portfolio to address metro capacity challenges. The 2.5GHz band is excellent for indoor coverage, outdoor densification with pico cells, and good as an (initial) wireless backhaul solution.

Clearwire’s established backhaul network is also a viable alternative to fiber backhaul. We believe the company continues to focus on outdoor small cells first, vs. indoor coverage using crowd sourcing data to determine where its pain points are and where the highest roaming expense to VZ occurs. We are encouraged that in region roaming expense continues to fall significantly as many coverage holes have been filled and software solutions have been found to prevent phones from roaming on the high cost Verizon network.

Update on Sprint’s Low-Cost Densification Program:

Outdoor Pico Cells Sprint shares have been volatile following the Re/Code article this month which suggested that Sprint will be decommissioning cell sites as part of the new lower cost network strategy. Management clarified that this is not correct, and we believe that the cost savings reported were against what the company may have spent using established vendors, not what they actually spend. Therefore we believe there is limited revenue risk to the tower segment which extend for the next 5- 7 years, but may lower future revenue streams which we do not believe the market has factored in due to the company’s weak balance sheet and expectations for consolidation over this time frame.

How can Sprint leverage its 2.5 GHz spectrum portfolio to improve network quality?

2.5 GHz spectrum is the basis of Sprint s LTE plus network and makes up the bulk of Sprint’s spectrum portfolio. Sprint controls approximately 120 MHz of 2.5 GHz spectrum in 90% of the top 100 U.S. markets. If Softbank can create low-cost Pico and CPE solutions using 2.5 GHz spectrum to densify its network, Sprint will have the potential to become the lowest-cost and fastest data network among the national carriers that are migrating to a greater dependency on low-cost Wi-Fi spectrum ahead of a migration to low-cost, shared LTE spectrum in the 3.5 GHz band and beyond.

Timeframe: 12 to 24 Months

How can the company shift away from expensive coverage improvement but still improve network quality?

Sprint is shifting away from high-cost macro coverage improvement to less costly surgical capacity improvement. Despite network coverage improvement from Network Vision (NV), substantial coverage gaps still exist, and network congestion is compounding challenges. Network quality remains poor in the eyes of consumers. The good news is that 2.5 GHz deployment will be quick (though now targeted), and in the postpaid segment, management has cleared the decks of 3G devices and is focusing on tri-band devices, which may provide 3G refarming opportunities at 1.9 GHz. LTE is now used by the postpaid segment 94% of the time. Key will be clearing 3G devices in the prepaid and wholesale segments.

Timeframe: 12 to 24 Months

Sprint’s Pricing Promotion:

Aggressive pricing promotion appears to be revenue accretive Sprint offered 50% off the price off most Verizon, AT&T, and T-Mobile rate plans during the biggest switching period of the year. Results exceeded expectations in terms of customer demand and the number of lines per account that were coming in. Sprint has extended the offer for another month. Management calculates the average customer life value of this year’s additions is 33% higher than a year ago. Furthermore, Sprint’s share of industry postpaid phone gross adds increased by 150 basis points year-over-year to the highest level in almost 3 years. Revenue accretion is a function of incoming customers paying similar to what they paid Verizon or AT&T as they are taking more data. Furthermore, Sprint is seeing a lot more multi line customers. As a result average billing per account and per user is increasing. Postpaid average billing per account is up 4% YOY while average billing per user (i.e. service plus handset revenue) is up 3% YOY. Higher installment billings and lease revenues more than offset the lower monthly service charges offered in conjunction with device financing options as well as the fact that average lines per account increased 5% year-over-year. Total service revenues plus installment billings and lease revenues of $7.1B increased 1% year-overyear. In terms of device leasing 65% of postpaid device sales were financed consistent with the prior two quarters and 46% a year ago. Furthermore 55% of postpaid sales selected leasing plans which was up slightly from last quarter.