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Contributors: Douglas McIntyre Jon C. Ogg

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Thursday, August 03, 2006

How Does Sprint Really Compare to Its Peers?

Stock Tickers: S, VZ, T, Q, CBB

Sprint NexTel $17.14 (-$2.99, -14.8%)
Verizon (VZ) $33.32 (-$0.21, -0.6%)
AT&T (T) $30.77 (+$0.19, +0.6%)
Cincinnati Bell (CBB) $4.47 (-$0.03, -0.6%)

While Verizon (VZ), AT&T (T), Qwest (Q), and even Cincinnati Bell (CBB) have been performing well you will notice that Sprint NexTel (S) has plummeted to new 52-week lows after a poor earnings report.

The company posted net income from operations of $0.32 EPS versus $0.33 estimates, but its net EPS after the merger costs from NexTel was a mere $0.12. Revenue in the second quarter increased 76 percent because of the NexTel merger to $10.0 Billion versus $10.4 Billion street estimates. It also lowered guidance for annual operating income on EBITDA from $13 billion to between $12.6 billion and $12.9 billion. Acquisition costs for newer high-end customers are taking their toll, and they also had lower long distance revenues like the rest of the industry.

To make matters worse, Moody's has placed Sprint Nextel Corporation (S) Baa2 senior unsecured long-term debt rating and its Prime-2 short-term debt rating on review for possible downgrade. This potential cut reflects concerns that the $6 billion stock repurchase plan and the combined operational weakness and intensifying competitive challenges may alter previously expected credit metrics. Moody's noted current expectations would only be a change by one notch, which means the company would Not lose its investment grade status.

While Sprint does have much of its own natural network, it does have some reliance on existing networks owned by AT&T and Verizon. That is the case with most telecoms, so it may not be worth a mention.

So what is different?

What really looks to have happened is that Sprint enjoyed its day in the sun since it acquired NexTel and these other telecoms are finally getting their day. Sprint is on a yearly low, and that is actually close to a 3-year low.

AT&T (T) has been incestuously cannibalized back into close what it was over 2 decades ago. Since SBC acquired AT&T and kept the AT&T brand name and if the FCC, FTC, DOJ, and others do not stop the merger with BellSouth (BLS) the combined company just has a winning geographic footprint. AT&T managed its earnings better by beating estimates, and its shares put in another year high today.

Verizon (VZ) is not at a yearly high, but it well off its lows. VZ shares are up about 10% since mid-May. The company also beat earnings this week and it is actually benefiting that Vodafone (VOD) is not going to try to sell its stake in Verizon Wireless for the $35 Billion to $45 Billion the street thinks it is worth (if that number changed, all apologies).

Qwest Communications (Q) also put in yearly highs yesterday. Talk about a turnaround company. Q is up over 100% from the lows of the last 52-weeks, and employee morale is much higher. S&P even raised its debt rating on Q after the company not only beat expectations this week, but it swung to a natural profit. S&P even said, "We are surprised by Qwest's relative access-line stability compared with peers, amid rising competition. We are boosting our 2006 EPS estimate by 12 cents to 19 cents, and we see 22 cents in 2007." Unfortunately, they said the stock was overvalued and placed a raised target value of $6.00 on the stock. The company was even able to launch another $500M debt private placement.

Even the smaller remaining Baby Bell that everyone has forgotten about, Cincinnati Bell (CBB), posted a year high yesterday. It also swung to a natural profit for the quarter. It also grew total subscribers, despite a small drop in land lines. It actually has been winning and adding subscribers to its premium bundled services, and that is where Sprint faltered. C-Bell is a tiny geography with its footprint in an area around Cincinnati, other parts of Ohio, parts of Kentucky, and parts of Indiana. By the way, why hasn't someone acquired CBB yet? It is a member of the "BAIT SHOP" and should be acquired. It has a tiny market cap of $1.1 Billion and would be incredibly easy to integrate.

What would a contrarian say?

There is still some concern that AT&T won't be able to do everything it wants with BellSouth since it will have such a dominant footprint in the center of the nation. Verizon will be spinning off some operations down the road, and will at some point have to bite the bullet and pay whatever they have to pay Vodafone to take back the stake in the company. Qwest has been looking and continues to look for ways to get back a portion of what it used to be. Cincinnati Bell should get gobbled up by another telecom. It is no secret that cable companies have had more success so far in stealing phone customers compared to telecoms winning IPTV customers as a cheaper alternative to cable. VoIP pure-play offerings are still growing and will continue to take away total land lines from the telecoms, and all of the new wireless pure-plays and even broadband over power lines make you wonder about old world telephone lines. Net neutrality has also already been compromised.

The predictable research reports point that this won't go away soon and the company may take a while to turn around. That very well may be true. What you still have to ask is just how much bad news is already baked in. Pairs Traders (arbitrage betters that bet one stock will do better or not as bad as one of its peers) are probably looking at these price ratios now. Pairs trading is much harder now with interest rates over 5% instead of about 2%, but this does still exist.

This looks like a situation where patience will win for new investors looking at Sprint NexTel, but you have to wonder with shares down over 37% from its highs and at new 52-week lows how much is already being priced into the stock. Give this a few days to let the analysts do whatever damage they will wield and then you can start looking into it on a comparative value basis.

Jon C. Ogg
August 3, 2006

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