Moody's Upgrades Sprint's Debt Ratings Following Softbank Takeover
Published on: 21st Jul 2013
By: Ian Mansfield
Moody's Investors Service has upgraded several ratings of Sprint debt ratings following the closing of the merger agreement with SoftBank and a separate merger agreement with Clearwire.
SoftBank, with an issuer rating of Ba1, acquired a 78% stake in Sprint, a transaction valued at $21.6 billion. Moody's believes that the merger with SoftBank will help Sprint to improve its operating performance in the highly competitive US wireless industry due to the infusion of $5 billion of new equity capital and SoftBank's track record of operational turnarounds of wireless companies in Japan (increasing market share and expanding margins). The merger with Clearwire, a company with a vast holding of spectrum, addresses Sprint's spectrum needs for at least the next several years.
Sprint's Ba3 Corporate Family Rating recognizes its large scale, its valuable spectrum assets, slowly improving operating profile, substantial liquidity, and the implicit support from Sprint's parent company and majority shareholder, SoftBank. Offsetting these strengths are high leverage, weak margins, and our projection for negative free cash flow through 2015. Near flawless execution across all aspects of the business, including the requirement to quickly redesign and modernize its entire network will be necessary before Sprint can hope to grow its market share in the brutally competitive US wireless industry.
Sprint and SoftBank will look to quickly maximize synergies after the closing of the deal. Reducing operating expenses will be crucial to successfully executing a financial turnaround. Combined, Sprint and SoftBank are expected to have the third largest position in terms of smartphones sold in the Japan and United States. With this scale, the company should be able to order larger numbers of smartphones at lower prices than they pay today. SoftBank has a proven track record and significant expertise in the wireless industry and will look to maximize network efficiency in order to reduce network operating expenses, reduce Information Technology-related costs, and improve churn as Network Vision is further deployed. Capital efficiency should also be realized due to the combined company's larger scale and Sprint's enhanced spectrum portfolio following the closing of the Clearwire deal. SoftBank believes that a 32-36% reduction in capital spending through synergies can eventually be achieved. SoftBank is experienced with managing heavy wireless traffic, building and deploying TDD-LTE technology and building out and maximizing core capacity at cell towers.
Wireless data demand is driving up spectrum needs for carriers as well as the perceived value of spectrum. Suffice to say, Sprint was facing a spectrum shortfall issue and the company's acquisition of Clearwire addresses spectrum needs for at least the next several years to support future growth. Clearwire's vast spectrum holdings in the 2.5 GHz band provides Sprint with tremendous depth and a platform for differentiation. With the expertise and guidance from SoftBank, we anticipate Sprint will leverage its 2.5 GHz spectrum capacity to achieve sustainable competitive speeds on its network.
In order for Sprint to reach its target goal of 200 million POPs covered by 4G LTE by year-end 2013 and complete Network Vision, capital spending will remain highly elevated through 2014. The company has publicly stated that it plans to spend a total of $16 billion in capital in 2013 and 2014. Moody's expects capital spending to decline to about $6 billion (unadjusted) annually after 2014. Sprint and Clearwire had a little over $8 billion of cash at the end of the 1Q 2013. Capital spending totaled almost $1.5 billion during the quarter. Sprint was scheduled to receive about $2 billion of new equity capital from SoftBank when their transaction closed and was expected to spend about $4 billion to purchase the shares of Clearwire that it didn't already own. High capital spending, modest revenue growth and low EBITDA margins supports Moody's projection for negative free cash flow through 2015. We project over $10 billion of cumulative negative free cash flow through 2015. Moody's expects Sprint will raise additional capital, either by going to market or receiving additional funding by SoftBank, to address its cash needs over the next few years.
Moody's believes that Sprint is currently at a significant competitive disadvantage to Verizon and AT&T since the two largest US wireless carriers have much larger LTE coverage today, an increasingly important factor behind subscriber provider decisions. Also, Verizon and AT&T have recently intensified their efforts to gain prepaid subscribers (a customer set the companies did not focus on previously) which makes up about one-third of Sprint's retail subscriber base. In addition, T-Mobile USA recently came out with some aggressive service pricing plans and a new program called JUMP, which allows customers to upgrade their phones up to twice a year. However, Sprint, along with T-Mobile USA, still have the benefit over Verizon and AT&T of offering unlimited data plans (albeit with weaker current LTE coverage compared to Verizon and AT&T). Unlimited data plans also run the risk of restraining future margin expansion at the expense of retaining customers as the demand for wireless data will continue to increase.
The ratings for the debt instruments reflect both the overall probability of default of Sprint, to which Moody's assigns a PDR of Ba3-PD, and the loss given default assessments of individual debt instruments.
Sprint's $3.0 billion unsecured credit facility is rated Baa3 (LGD2 - 14%). The three-notch lift from the Ba3 CFR reflects the structural seniority provided by the guarantees from the operating subsidiaries of Sprint. Sprint's Senior Unsecured Notes are rated B1 (LGD5 - 74%) and Sprint's Junior Guaranteed Unsecured Notes are rated Ba2 (LGD3 - 37%). The Ba2 rating assigned to Sprint's Junior Guaranteed Unsecured Notes reflects its seniority ahead of Sprint's Senior Unsecured Notes, and its subordinate ranking to the Senior Unsecured Guaranteed Bank Credit Facility.
The B1 (LGD5 - 74%) rating for Sprint's subsidiary, Sprint Capital, reflects the guarantees from the parent on a senior unsecured basis. The senior secured 2nd priority notes of Sprint's subsidiary, iPCS Inc., are rated B1 (LGD5 - 74%) and is secured solely with the underlying assets of iPCS. Moody's rates Clearwire's senior secured 1st lien notes and senior secured 2nd lien notes Baa3 (LGD1 -- 1%) and Baa3 (LGD1 -- 2%), respectively, three notches above the Ba3 CFR due to their priority claim and significant loss protection. The 1st lien notes are secured by substantially all of Clearwire's domestic assets, and are guaranteed, on a joint and several basis, by all domestic operating subsidiaries. Reflected in our LGD analysis is Moody's expectation that Sprint will likely redeem $2.947 billion of Clearwire's 1st lien notes due 2015 within the next 12 months and refinance the debt at Sprint's parent level. Moody's also ranks the company's $1.0 billion secured equipment credit facility ahead of the unsecured credit facility and pari passu to Clearwire's 1st lien notes.
The stable outlook reflects our belief that operational performance (churn, subscriber trends, market share) will improve and that operating synergies will be achieved enabling slow, but steady margin expansion. The stable outlook also incorporates an expectation that the Network Vision project will remain on schedule and will produce the expected benefits.
Sprint's ratings could be raised if its turnaround accelerates. Specifically, if leverage were likely to drop below 4.0x, and free cash flow were to turn positive rating pressure would ensue (note that all cited financial metrics are referenced on a Moody's adjusted basis).
Sprint's ratings could be lowered if the network upgrade falls behind schedule or doesn't yield the financial and operational benefits promised or if Sprint's competitive position deteriorates as evidenced by postpaid CDMA churn rising (outside of normal quarterly variances) or overall market share declines. Also, if the company allows its liquidity position to weaken significantly, negative rating pressure will ensue. Specifically, if leverage was likely to exceed 6.0x (Moody's adjusted) on a sustained basis, the ratings could be downgraded.