Sprint Debt Ratings Fail to Get an Upgrade Following Softbank Takeover
Published on: 12th Jul 2013
By: Ian Mansfield
Fitch Ratings has affirmed Sprint Nextel's long term debt ratings at B and also removed the company from Rating Watch Positive and assigned them a Stable Outlook.
The rating affirmation reflects Fitch's view that Sprint's current legal, operational and strategic ties to Softbank do not warrant additional notching support at this time based on Fitch's parent and subsidiary rating linkage criteria. Thus Sprint's IDR is based on its stand-alone credit profile and does not benefit from an uplift in ratings. The two companies do not share legal or operational ties for common treasury or integrated operations.
Softbank's decision to divert $3 billion in cash from Sprint to shareholders reflects a concern with Softbank demonstrating an appropriate level of tangible support to Sprint's credit profile in order to link the ratings. A greater indication of future financial support and strategic importance to Sprint by Softbank would provide a linkage to the ratings and for notching lift to Sprint's IDR.
Weak Financial Profile, Credit Metrics
Fitch expects Sprint's financial profile to remain weak through 2014 due to the significant cash deficit during the next two years and the associated debt borrowing that will increase leverage. Sprint estimated this deficit at approximately $10 billion in its June 2013 proxy filing driven by $16 billion in capital investment to keep pace with growing industry demand and the competitive environment.
Fitch believes the cumulative $28 billion in capital spending the next four years also reflects the underinvestment in Sprint's network and the need to accelerate the deployment of capital to improve Sprint's competitive position. Additionally, DISH's pursuit of Sprint and Clearwire had a negative impact on Sprint's available liquidity for other strategic initiatives of $4.7 billion.
Looking forward, as Sprint leverages it cost reduction efforts, substantial margin expansion should occur in the 2014 and 2015 timeframe. Cost reduction efforts could drive up to $2 billion in savings. The improved cash generation when coupled with reduced capital investment should allow for the company to strengthen its financial profile, including the potential to generate free cash flow by 2015. Leverage is expected to approach 5.5x by the end of 2013 before declining in 2014.
Sprint also faces material execution risk across the numerous strategic objectives that the company is pursuing. Fitch remains concerned with Sprint platform gross additions trends that when adjusted for Nextel subscriber recapture, declined in excess of 20% for the past four quarters. Consequently, postpaid revenue growth declined to 0% year-over-year for the first quarter 2013 compared to a peak growth of 6% during late 2011 to mid-2012. During this time, Sprint prioritized its marketing spend for the recapture of its iDEN subscribers and Verizon Wireless took share by leveraging its 4G LTE leadership position across its national footprint. As such, Sprint will need to reinvigorate growth in light of this increased competitive activity.
The accelerated network investment to improve capacity, data bandwidth and customer experience is a key strategic component of Sprint plans. The company hopes the improved network when combined with its differentiated unlimited plan and Softbank's expertise will increase its share of industry gross additions. Fitch believes Verizon and AT&T Wireless are currently much better positioned to leverage their scale, capital investment, subscriber bases and spectrum portfolios to capture additional share and future growth, particularly through the share data plans. These plans will likely result in even stickier subscribers as consumers attach more devices, creating further barriers to churn.
Consequently, Sprint's challenge is magnified, as industry postpaid and prepaid additions are expected to contract further as the industry matures. Additional avenues for incremental revenue growth include mobile broadband/tablet devices and machine-to-machine opportunities.
Softbank's cash infusion materially strengthened Sprint's flexibility to pursue key consolidation and spectrum opportunities. Fitch views Clearwire's network and spectrum assets as integral to Sprint's long-term evolution (LTE) plans to deploy high-band spectrum in high-capacity areas, particularly within the urban cores under Sprint's control. This strengthens Sprint's long-term competitive position and ability to offer a differentiated unlimited wireless broadband plan versus its national peers.
Given Sprint's deep 2.5 GHz spectrum position and unbalanced spectrum portfolio, Fitch believes Sprint could pursue opportunities to swap/sell 2.5 GHz spectrum and increase its holdings of other spectrum bands including the sub 1 GHz band through the 600 MHz broadcast auction. This would enhance Sprint's financial flexibility and allow for an expanded 2.5 GHz device ecosystem.
Sprint and DISH could also find themselves at odds again as the FCC finalizes its plan to auction the PCS H-block in late 2013, or more likely in 2014. This spectrum is particularly attractive to each because it is adjacent to Sprint's existing spectrum and strategic to DISH's AWS-4 spectrum holdings. An H-block auction in the 2014 timeframe could increase Sprint's expected deficit if the company participates in the auction.
Liquidity, Maturities & Financial Covenants
Sprint's liquidity position is supported by $7.8 billion of cash and $2.1 billion borrowing capacity under a revolving credit facility. Softbank will contribute an additional $1.9 billion of cash at closing. Sprint closed a new five-year $3 billion credit agreement earlier this year. As of March 31, 2013, approximately $925 million in letters of credit were outstanding. Sprint also maintains a second tranche of a $500 million vendor financing facility that became available for borrowing on April 1, 2013.
Fitch expects Sprint will maintain at least $2 billion of cash going forward to maintain adequate liquidity for its strategic plans. As such, given the high cash requirements to fund the operating deficit related to the capital investment, the Clearwire acquisition and potential spectrum auction, Fitch expects Sprint will substantially increase debt during the next year.
Debt refinancing and redemptions have significantly reduced Sprint's maturity profile (excluding Clearwire) from previous years. During the next four years, $356 million, $292 million, $611 million and $2,111 million comes due, respectively. Sprint will consider opportunities to refinance Clearwire's high-coupon debt. Clearwire has $2.95 billion of 12% first-priority secured notes due December 2015. The secured notes currently have optional redemption rights at 106%. This will reduce to 103% in December 2013. The $500 million 12% second priority notes are due in 2017 with optional redemption rights beginning December 2014 at 106%. The $300 million 14.75% first priority secured notes mature in the fourth quarter of 2016 and contain a make-whole premium, thus limiting refinancing options.
Financial covenants with the new credit facility have significant cushion against the expected leverage increase with current total leverage ratio not to exceed 6.25 through June 30, 2014. As of March 31, 2013, the leverage ratio was 4.25.
The unsecured credit facilities at Sprint benefit from upstream unsecured guarantees from all material subsidiaries. The credit agreement allows carve-outs for indebtedness composed of unsecured guarantees that are expressly subordinated to the credit facility. The unsecured junior guaranteed debt is senior to the unsecured notes at Sprint Nextel and Sprint Capital Corporation. The unsecured senior notes at these entities are not supported by an upstream guarantee from the operating subsidiaries.
The $1 billion vendor financing facility is jointly and severally borrowed by all of the Sprint subsidiaries that guarantee the Sprint credit facility, Export Development Canada loan and junior guaranteed notes. The facility additionally benefits from a parent guarantee and first priority lien on certain network equipment. This places the vendor facility structurally ahead of the unsecured notes.