Sprint's credit ratings get downgraded by Moody's amid unease about its long-term turnaround prospects

Sprint (NYSE: S) CEO Marcelo Claure and Chairman Masayoshi Son have spent the last month and a half proclaiming that they have faith in Sprint and its turnaround efforts, with SoftBank snapping up shares in a show of confidence. However, some in the investment community are not as sure, and Moody's Investors Service downgraded its credit ratings on Sprint, saying that the carrier is not doing enough to right itself.

"Today's rating action reflects Moody's view that the numerous operational and network initiatives, management changes, and funding plans recently announced by Sprint and its parent company and majority shareholder, SoftBank Group Corp. ("SoftBank"), will be insufficient to stabilize Sprint's operations in the next few years," Moody's said in a statement.

"The brutal competition now playing out in the U.S. wireless industry will pressure the financial performance of even the strongest operators," the ratings firm added. "Consequently, we expect Sprint's cash consumption to remain high, liquidity to remain weak and leverage to increase. Finally, we remain concerned about the ability of Sprint to refinance its large upcoming debt maturities absent a much stronger commitment from SoftBank to the long-term strategic importance of Sprint in SoftBank's overall plans. The outlook remains negative."

Sprint has recently shown improvements in churn and postpaid handset losses. Although Sprint lost 12,000 postpaid phone customers in the second quarter, that in itself is a major improvement for the carrier, compared to 620,000 in the year-ago quarter. Sprint said that for the first time in nearly two years it recorded monthly postpaid phone net additions in both May and June. Sprint also said postpaid churn was 1.56 percent in the second quarter, a record low, compared to 2.05 percent for the year-ago period and 1.84 percent for the first quarter. 

Despite this, Moody's thinks "the capital markets will be disinclined to provide funding to Sprint without enhanced collateral in light of its ongoing very large cash needs. We believe that Sprint (and Softbank) recognize this fact." Sprint burned through $2.2 billion in cash in the second quarter.

To address this, Sprint and SoftBank have announced plans to establish two leasing companies for both handsets and network equipment for Sprint's network densification program. As a result, Sprint said it currently does not expect to raise additional capital through the public debt or equity markets in the foreseeable future, nor does it currently expect to sell any of its spectrum.

Moody's said this is a positive step but could have downsides. "While details haven't been finalized, the credit impact could be positive for Sprint since liquidity is a key weakness for the company as it invests in a turnaround," the firm noted. "However, if the entity does not represent a permanent partner for Sprint, one which can endure all phases of the business or credit cycle, then the financial obligation of the leasing company would likely be added back to Sprint's adjusted credit metrics and further reflected in its long-term ratings."

Further, Sprint's debt maturities "ramp up significantly starting in December 2016 when $2 billion of senior notes mature. Annual debt maturities over the following five years average about $2.5 billion per year."

With the incentive auction of 600 MHz broadcast TV spectrum looming in 2016, Moody's thinks Sprint will likely need to participate because "a balanced mix of spectrum is critical for operators to compete effectively and profitably in the U.S. over the long-term" and that "consequently, we believe Sprint may need to reconsider its reluctance to sell some of its very deep holdings of 2.5 GHz spectrum."

Meanwhile, MoffettNathanson analyst Craig Moffett, who rates Sprint as a stock to "sell" with a price target of $2, said in a research note that SoftBank's share repurchases in August, which have boosted Sprint's stock, as well as the leasing vehicles, buy Sprint time.

However, he said that SoftBank increased its stake in Sprint from 79.6 percent to 81.9 percent likely because it was "eager to quell concerns about Sprint's solvency." He noted that Sprint's shares had fallen 17 percent in the four months prior to the repurchasing, and that had "created an air of crisis among SoftBank's creditors."

Moffett also said that SoftBank could have bought Sprint's shares because it was "eager to remove the cloud of possible Sprint insolvency in order to facilitate negotiations for an off-balance sheet handset financing vehicle," which has still not yet been announced. Moffett thinks the leasing vehicles will give Sprint enough cash to sustain operations into 2018, when SoftBank might try again to merge Sprint with T-Mobile US (NYSE:TMUS) under a new administration.

For more:
- see this Moody's release

Related articles:
Sprint's Claure: Network improvement, awards in Denver are a harbinger of things to come nationwide
SoftBank's share purchases help buoy Sprint's stock and boost market value by $6.7B
Sprint's Claure gives himself 3-5 years for turnaround after 1 year on the job
Sprint to abandon 2-year contracts by year-end, embrace leasing exclusively
Sprint extends Claure's contract until 2019, will give him 10M shares if he gets stock to $8
SoftBank buys $87M more in Sprint shares in show of confidence

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