Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.
Reason for Report: 1Q13 Earnings Update
Prev. Ed.: Apr 15, 2013; 4Q12 Earnings Update
Brokers’ Recommendations: Neutral: 52.94% (9 analysts); Positive: 17.65% (3); Negative: 29.41% (5) Prev. Ed.: 10; 3; 3
Brokers’ Target Price: $5.45 (↑$0.51 from the last edition; 11 analysts) Brokers’ Avg. Expected Return:
(7.8%)
*Note: Though dated Jul 12, 2013, share price and brokers’ material are as of Jun 17, 2013.
Note: A Flash Update was done on May 1, 2013 (1Q13 Earnings Update; Missed Expectations)
Note: The tables below (Revenue, Margins, and Earnings per Share) contain material from fewer brokers’ than in the Valuation table.
Portfolio Manager Executive Summary
Leap Wireless International Inc. (LEAP or the company) as a spin-off of QUALCOMM in June 1998. Presently, it is the seventh-largest wireless carrier in the U.S. that provides innovative, high-value wireless services to a fast-growing, young, and ethnically diverse customer base. The company offers services in 35 U.S. markets covering more than 5.9 million wireless customers.
Key factors for evaluating an investment strategy for Leap Wireless are as follows:
• LEAP is the seventh-largest wireless carrier in the United States serving more than 5.9 million customers. The company primarily caters to suburban customers with low income.
• LEAP rolled out its highly innovative “Muve Music” service plan, which allows unlimited music download facility and is the first prepaid wireless carrier to offer Apple Inc’.s (AAPL) iPhones without any contract terms.
• The company has started deploying 4G LTE technology across its footprints and plans to cover two-thirds of its overall network foothold in the next 2-3 years. Moreover, Leap Wireless entered into a spectrum sharing partnership with T-Mobile USA, which will expand the two carriers’s 4G LTE network capability.
• Some of LEAP’s main competitors are MetroPCS Communications and America Movil’s (AMX) Tracfone.
Analysts’ Opinions: Of the 17 analysts in the Digest Group covering the stock, 52.94% provided neutral ratings, 17.65% adopted a positive stance while the remaining 29.41% were negative on the stock. The Zacks Digest target price ranges from a low of $3.00 to a high of $8.00, with the average at $5.45. The average expected return on the current share price is (7.8%).
Neutral (Neutral or equivalent outlook) – 9/17 analysts or 52.94%: These analysts hold a cautious outlook on account of increased competition in the pre-paid wireless market coupled with pricing constraints and poor financial results. According to these analysts, LEAP will face several headwinds from the sluggish economic growth, changing competitive landscape in the pre-paid space coupled with increased capital spending and higher leverage related to LTE network implementation. However, the analysts remain hopeful about the company’s strategic decision to target the postpaid subscribers by offering high-end smartphones at lower monthly rates. Moreover, the company is focused on improving its core Cricket wireless business and has enough spectrum to complete its initial 4G rollout.
Bullish (Buy or equivalent outlook) – 3/17 analysts or 17.65%: These analysts are bullish based on the availability of PCS and AWS spectrum, attractive plan offerings, and increased adoption of Android-based smartphones and Muve-enabled handsets. They also believe that Average Revenue Per User (ARPU) and cash flow will stabilize in the upcoming quarters.
Bearish (Negative or equivalent outlook – 5/17 analysts or 29.41%: These analysts with a bearish stance expect LEAP’s ARPU and margins to slow down in the forthcoming quarters as the smartphone market approaches maturity. Moreover, a highly leveraged balance sheet and increased competition in the pre-paid market coupled with higher costs associated with the deployment of LTE and sale of subsidized phones will further exert pressure on the company’s margins. Additionally, these analysts also remain apprehensive about the success of the new rate plans to be introduced in FY13 and believe that T-Mobile USA’s launch of LTE in LEAP’s market will put additional pressure on subscriber growth and margins.
Long-Term Outlook: Despite the challenging macroeconomic environment and competitive wireless industry trends, the company is looking forward to improve the growth prospects of the business through restructuring and cost-saving initiatives.
Increasing Competition: LEAP competes with at least 5–6 competitors in each of its operational markets. Intense competition in the wireless market, particularly in the prepaid segment, puts the carriers under pricing pressure, which eventually results in revenue and margin contraction. Moreover, the national carriers can target small players like LEAP to reach out to their potential customers.
Jun 17, 2013
Overview
Leap Wireless International Inc. (LEAP or the company) came into existence after its spin-off from QUALCOMM in Jun 1998. Headquartered in San Diego, Calif., LEAP provides innovative, high-value wireless services to a fast-growing, young, and ethnically diverse customer base. With the value of unlimited wireless services as the foundation of its business, LEAP pioneered both the Cricket and Jump Mobile services. The company and its joint ventures operate in 35 states including the district of Columbia and hold licenses in 35 of the top 50 U.S. markets. Through its affordable, flat-rate service plans, and Cricket, the company offers customers a choice of unlimited voice, text, data and mobile Web services. Jump Mobile is a unique prepaid wireless service designed for the mobile-dependent, urban youth market. For more information, please visit www.leapwireless.com.
Key investment considerations as identified by the brokerage firms are as follows:
Key Positive Arguments / Key Negative Arguments· LEAP offers a local unlimited calling plan that has resonated well with several relatively underserved market segments, including lower credit, youth, and the ethnically diverse demographics.
· LEAP's CPGA (cost per gross addition) and CCPU (cash cost per user) are among the lowest in the industry. Even with new entrants such as Boost Unlimited and Straight Talk, the firms believe that its distribution, network and operating cost model possess significant structural barriers to entry for nationwide providers.
· LEAP’s new innovative “Muve Music” plan has gained much popularity among its users. Moreover, higher sales of Android-based smartphones followed with the LTE 4G plan will drive ARPU growth, going forward.
· LEAP’s roaming wholesale agreement with Sprint Nextel (S) will provide nationwide 3G data services to its customers that will enhance its position as a national pre-paid wireless service provider. Moreover, its 3-year deal with Apple Inc. (AAPL) to sell iPhone 4S and iPhone 5 will reduce customer churn. / · Existence of execution risk as capital expenditure and start-up costs may increase with time. Moreover, lack of spectrum availability may exert pressure on bandwidth as the company started selling increased number of smartphones to its existing/new customers.
· With respect to the company’s senior secured credit facility, the company could be in breach of representations as to the reliability of prior financial statements. Moreover, LEAP’s highly leveraged balance sheet will also limit its expansion plan.
· Growing number of MVNO operators in the prepaid segment will continue to exert pressure on LEAP’s prepaid wireless market.
· The company’s inadequate spectrum can act as a potential threat. Moreover, the sale of the new iPhone 5 will further increase network traffic if more customers start using the device.
· Reduction in smartphone prices could be a
risk for the company as lower phone prices induce customers to change carriers.
Note: Note: The Ccompany’s fiscal year ends on Dec 31.
Jun 17, 2013
Long-Term Growth
Leap wireless is expected to benefit from the unprecedented demand of smartphones in the U.S. LEAP is focused on its long-term growth prospect and expects to expand its footprint across the U.S. LEAP sells unlimited wireless voice and data services to its customers at considerably lower rates than those of its larger wireless competitors. The analysts believe that the company’s business model enables it to serve certain portions of the population more profitably than its national competitors. Further, execution on new market builds, expansion of its distribution network coupled with new tariff plans and smartphone line-ups will be the key catalysts in the years to come. The 4G roaming agreement with LightSquared along with the development of new AWS spectrum markets will enable the company to deploy higher-speed services. Moreover, the company has adequate spectrum to complete its initial 4G rollout. LEAP has also entered into a 5-year agreement with Sprint nextel (S) to offer 3G services and a 3-year purchase agreement with AAPL to sell iPhones to its customers, which in turn will have a positive impact on its customer growth. Management plans to deploy LTE to two-thirds of its current network footprint over the next 2-3 years at less than $10 per covered POP. However, increased smartphone adoption and higher data consumption may force the company to increase its capacity either through spectrum acquisition or cell site additions. As the company is offering smartphones at subsidized rates to its new or existing customers, it will pressurize margins intially but the company will benefit in the long run fueled by higher subscriber and ARPU growth. However, owing to the economic uncertainty and stiff competition from large carrriers, LEAP is facing certain downside risks. Since LEAP’s customer base is predominantly the low-income group, its subscribers may be more sensitive to volatility in the economy. Going forward, LEAP expects to take its very popular Muve Music service to a larger scale by enhancing its retail precense. In the long run, the firms believe that the fragmented prepaid segment will get consolidated. The company will face huge liquidity crunch in the upcoming years as debts worth $1.4 billion will mature in the 2014–2016 period. This will act as a bottleneck for LEAP, since the company will not be able to invest in LTE platforms, which require huge investment. This will make LEAP lag behind its competitors in the long run.
Jun 17, 2013
Target Price/Valuation
Provided below is a summary of target price and rating as compiled by Zacks Research Digest:
Rating DistributionPositive / 17.65%↓
Neutral / 52.94%↓
Negative / 29.41%↑
Digest High / $8.00
Digest Low / $3.00
Avg. Target Price / $5.45↑
No. of Analysts Giving Target Price/Total / 11/17
Risks to the price target include but are not limited to:
Jun 17, 2013
Recent Events
On May 1, 2013, LEAP announced its 1Q13 financial results. Key highlights are as follows:
· Total revenue was $789.9 million in 1Q13 against $825.6 million in 1Q12 but well above the Zacks Consensus Estimate of $735 million.
· Gross margin was 35.5% compared with 38.3% year over year (y/y).
· EPS on a GAAP Basis was ($1.43) as compared with $1.28 per share in 1Q12 and was significantly lower than the Zacks Consensus Estimate of a loss of $1.20 per share.
On Apr 15, 2013, LEAP signed its first international agreement with leading Brazilian carrier, TIM Brasil. LEAP Wireless will offer its Muve Music service to the Brazilian carrier.
Jun 17, 2013
Revenue
Provided below is a summary of total revenue as compiled by Zacks Digest:
Revenue ($ in M) / 1Q12A / 4Q12A / 2012A / 1Q13A / 2Q13E / 2013E / 2014E / 2015EZacks Consensus / $738.0 / $2,963.0↑ / $2,805.0↓
Digest High / $826.0 / $756.0 / $3,143.0 / $790.0 / $752.9 / $3,042.0↑ / $3,025.0↑ / $3,090.0↑
Digest Low / $825.6 / $756.0 / $3,142.0 / $789.0 / $691.0 / $2,810.0↑ / $2,416.0↑ / $2,258.0↑
Digest Average / $825.7 / $756.0 / $3,142.3 / $789.8 / $734.2 / $2,960.1↑ / $2,791.5↑ / $2,674.0↑
Y/Y Growth / 5.9% / -1.5% / 2.3% / -4.3% / -6.7% / -5.8%↓ / -5.7%↑ / -4.2%↑
Q/Q Growth / 7.6% / -2.3% / 4.5% / -7.0%
*Note: Blank cells indicate the analysts did not provide any numbers
According to the company press release the Zacks Digest, the total revenue in 1Q13 was $789.8 million, down 4.3% y/y but increased 4.5% q/q.
During 1Q13, Leap Wireless lost around 93,037 net customers against a gain of 258,060 customers in the year-ago quarter. Total subscriber base, at the end of the first quarter of 2013, was 5,203,747, exhibiting a 16% year-over-year drop. ARPU was $43.72, up 2.7% year over year. Quarterly cost per gross addition increased 39% year over year to $317. Leap Wireless lost 8,502 net customers from its Wireless segment against a gain of 163,613 customers in the year-ago quarter. Consolidated customer churn rate was 3.6% compared with 3.3% in the prior-year quarter. Quarterly wireless churn rate was 2.9% compared with 3.1% in the year-ago quarter. Wireless subscriber base was 4,636,867, exhibiting a 10.3% year-over-year drop.
The company’s revenues comprise Subscription and Advertising revenues.
Provided below is a summary of segment revenues as compiled by the Zacks Digest:
Revenue Segment
In 1Q13, Service revenues were $773.9 million (93.7% of the total revenue), up 14.1% y/y and 6.1% q/q. Equipment revenues were $51.7 million (6.3% of the total revenue), down 49.1% y/y but increased 36.4% q/q.
Provided below is a summary of segment revenue compiled by Zacks Digest:
Revenue ($ in M) / 1Q12A / 4Q12A / 2012A / 1Q13A / 2Q13E / 2013E / 2014E / 2015ESubscriber-related revenue / $773.9 / $700.1 / $2,947.4 / $684.7 / $663.0 / $2,629.3↑ / $2,516.9↑ / $2,704.0↑
Equipment sales and other revenue / $51.7 / $55.8 / $194.9 / $105.2 / $75.9 / $352.4↑ / $342.3↑ / $386.0↑
Total Revenue / $825.7 / $756.0 / $3,142.3 / $789.8 / $734.2 / $2,960.1↑ / $2,791.5↑ / $2,674.0↑
*Note: Blank cells indicate the analysts did not provide any numbers
Outlook
Management will continue to offer value-added products and services, which include better smartphones, improvement in dealer incentive plans, up gradation of Muve Music product and lucrative tariff plans in 2013. This will help the company to drive its subscriber growth, consequently improving customer churn. The company also plans to move its subscribers to premium plans, which it believes will not only boost ARPU growth but will also drive revenues. Moreover, the company has already covered 21 million POPs with 4G LTE and plans to launch the service to 10 million POPs by the end of 2013. LEAP also plans to expand its retail presence by launching 250 new Cricket branded shops and 5,000 additional national retail locations in 2013, thereby improving subscriber growth.