As you may already know, Apple (AAPL) recently released the new iPhone 4S, and Sprint (S) is now available as a carrier. Thanks to a combination of Steve Jobs’ passing and a 4S instead of a 5, many investors wrote off the new iPhone as a bust.
Given that Sprint had just signed an enormous $20 billion deal with Apple to buy 30.5 million units, several analysts downgraded Sprint and the stock immediately sold off, almost down to $2 per share. Management admitted the deal may eat up around $1 billion in free cash flow, but they, as do we, think the investment is worthwhile.
We think it’s time for naysayers to stop doubting the iPhone and accept that it is the premier phone. And with Research In Motion’s (RIMM) Blackberry faltering, we think Apple will eventually become the number one player in the mobile space. According to recent studies, iPhone retention rates hover north of 90%, while Android (Google) retention is less than 50%. However, a number that we think is significantly compelling is that over 40% of current Android users plan to switch to the iPhone, while only between 5%-10% of iPhone users intend to switch to Android.
We think this supports our overweight position in Apple in the portfolio of our Best Ideas Newsletter, but such a trend also suggests that Sprint needed this deal with Apple. With the migration to iPhone and the probability that it becomes the number one mobile device, Sprint risked losing many of its existing subscribers to AT&T (T) and Verizon (VZ) on the hunt for the iPhone. Since Sprint is the least expensive mobile carrier, we suspect the iPhone will be a net benefit for the company (an idea we already had baked into our model). We think CEO Dan Hesse is the right man to lead a debt restructuring, if necessary.
Furthermore, we think Sprint will be able to easily sell 30.5 million iPhones. No, we don’t think every current Sprint postpaid subscriber (32.9 million at the end of Q2) will convert over to the iPhone. That implies a conversion rate of 93%, which would be a bit extreme. However, we suspect some of the 13+ million prepaid subscribers will make the leap to postpaid in order to get an iPhone and that most people switching with Sprint will pick up the iPhone.
If Sprint can get a 60% conversion rate (about 19.7 million iPhones), they should have no problem selling 11 million units to prepaid and new subscribers. Regardless, this idea does not materially affect our fair value assumption of Sprint, and we continue to consider the stock fairly valued at today’s levels.