Clearwire faces a nagging “cash hole in its business plan and Sprint is the only game in town to fill it.” That’s the opinion of New York money manager Pardus Capital whose president, Karim Samii, just wrote a 2,257-word letter to Clearwire interim CEO John Stanton explaining his dissatisfaction with the direction of the Kirkland broadband wireless company.
Samii offers a compelling read on the troubles facing Clearwire, with the shareholder placing most of the troubles on the company’s complex relationship with Sprint. He writes:
“Clearwire is critical to Sprint. Its best customers are on your network. It has no 4G offering without Clearwire. Yet Sprint does not need or want Clearwire to trade to $15 or $20 per share. Sprint believes its best play is to keep Clearwire depressed in value and cash-starved, which leaves Clearwire vulnerable to a cheap take-under. We happen to think this is not smart for Sprint: it delays the 4G rollout and means Sprint is likely to have to fund the network build one way or the other. We also believe the real negotiating leverage should work the opposite way: Clearwire has other strategic options; Sprint has no realistic replacement for your network and spectrum.”
In order to reverse this course, Samii suggests that some of Clearwire’s valuable spectrum be sold. That move, among other things, would demonstrate that “Sprint needs Clearwire as much or more than Clearwire needs Sprint,” he writes.
A Clearwire spokesman declined to comment on the letter, which was made public Wednesday. “Clearwire manages its business in the best interests of all of the company’s shareholders. We have received Pardus’ inquiry, however, it is against our policy for us to discuss shareholder interactions publicly,” the spokesman said. Shares of the company are off 43 percent in the past 12 months.
You can read the full letter here:
Dear Mr. Stanton:
We have owned Clearwire common stock since last fall and we have increased the position size even as the stock has declined in value. We want to use this letter to briefly summarize our views and concerns about conflicts of interests we believe may be adversely impacting decisions at the company and leading to the Company’s overall poor perception in the market. We have asked Paul Blalock to arrange a meeting or call with you to discuss our views, before we approach other shareholders.
We have been investors in wireless telecom for many years and remember you well from our past funds, which held large stock and credit positions in both Western Wireless and VoiceStream Wireless. Given our successful experience with you as an operator and smart dealmaker, we were pleased when you assumed the chairmanship of Clearwire in January. Unfortunately, the stock’s performance has not borne out our initial optimism, trading down from $5.91 on the day you became chairman to $4.49 on May 18, a drop of nearly 25%. During the same period, Sprint shares have traded up from $4.36 to $5.33, an increase of more than 22%.
We find troubling some of Clearwire’s recent steps which suggest to us the company is increasingly disadvantaged vis-à-vis Sprint. In short, it appears to us that other strategic options have been delayed, downplayed or ruled out, leaving Clearwire with a cash hole in its business plan and Sprint as the only game in town to fill it. We are concerned this will lead to a network sharing deal with Sprint that does not reflect the best economics for Clearwire. Further, the structure of the network sharing deal could all but foreclose other strategic options for Clearwire, effectively giving Sprint an exclusive on an eventual take-under of the company, to the public shareholders’ disadvantage.
For the reasons we detail below, we believe the non-Sprint designated directors should form a Negotiating Committee that would consult closely on the negotiations you are leading. At the same time, the Strategic Committee should continue to explore strategic alternatives to Sprint, including selling excess spectrum at a premium to the value implied by Clearwire’s enterprise value. A small spectrum sale, or even re-engaging in a serious process to reach a conclusion in the near term, will:
Give the market a clear path to fully funding the Clearwire’s current business plan.
Underscore Clearwire’s value and prove the financial backstop to which you referred in the 1Q earnings call.
Demonstrate to Sprint, and the market, that Sprint needs Clearwire as much or more than Clearwire needs Sprint.
Provide a measure for the outcome of the Sprint negotiations and ensure that Sprint, if it wants to effectively assume control of Clearwire or its assets, pays the highest and best price.
From the public market’s perspective, these are the key events of the last several months:
Heading into YE 2010, it was clear the company would face a cash shortage by mid-2011 and would likely have a going concern issue. Clearwire was also in the midst of the wholesale pricing dispute with Sprint, and it was clear the relationship had been souring at least since Mr. Hesse and the other Sprint insiders resigned from the Board in September. The Strategic Committee, of which you are a member, also was formed in September.
Management responded by (i) cutting costs, essentially halting market growth at 130mm POPs, (ii) scaling back the retail part of the strategy, and (iii) pursuing a three-prong approach to capital raising: raise debt, raise equity (preferably strategic) and sell excess spectrum.
The company ultimately placed more than $1.4B of debt, of which $729 million was Exchange notes. None of the strategic investors participated in the placement. Apart from the dilution to shareholders and pressure on the stock from noteholders’ delta hedging their position, the placement increased the cash burn to Clearwire from interest alone to $480 million per year.
Mr. McCaw resigned. The impression is that he and Sprint, in particular, had come to have strong disagreements. Mr. McCaw designated as his successor Mr. Wolff, who came with an advisory services agreement that entitles Mr. Wolff to a fee if Clearwire enters into on which he advises. Mr. Wolff promptly became chairman of the Strategic Committee. We believe this type of fee arrangement is unusual for a director, and more so the chair of the committee, and it would be helpful if Clearwire released the details of the agreement so that the market can be assured Mr. Wolff has no financial incentive to favor one outcome over another.
Well into the first quarter, Clearwire told the public it would continue to pursue spectrum sales, and that it had multiple regional, national and global interested parties, both strategic and private equity. We understood the company believed it needed to resolve the Sprint pricing dispute prior to moving forward with the spectrum sale and that, in February, the dispute resolution was “imminent.”
Bill Morrow is a good operator, and his departure, along with the other executives, again appeared to signal potential appeasement to Sprint over pricing and strategy.
The market also took as a negative the ultimate resolution of the Sprint pricing dispute. We expected the deal would yield around a penny per megahertz for Clearwire. It appears to have come in closer to $0.007/MHz. Another way to look at it: instead of yielding $7.60 per in-market subscribers in more mature markets, Clearwire should be making $10.00 per sub. The market took this as a “sweetheart” deal for Sprint.
Potential Cash Shortfall
After the 1Q earnings call, in the face of good operating matrices, strong sub growth and increased full-year guidance, the stock fell yet again. Here’s why: Clearwire has a cash hole in its business plan. While Hope Cochran said the company has enough cash for at least 12 months, the reality is that Clearwire will face a going concern issue again at year-end. We expect the shortfall will be relatively small (assuming Clearwire stays at 130 million POPs and does not convert to LTE), but sell-side analysts’ estimates have a wide range, and the uncertainty weighs on the market. Yesterday, CNET highlighted the cash hole in its reporting of an interview with COO Prusch (headline: “Yes, Clearwire really is on the ropes”; first line: “There’s no doubt Clearwire faces a cash crunch among many other challenges . . . .”).
Unfortunately, management compounded the problem with the guidance on how to fill the hole. Hope stated:
“We are considering alternatives which could include the issuance of additional equity securities, including strategic equity, which is our preference; additional debt financing; and lastly, the sale of assets not essential to our business. We recognize the strategic advantage of our spectrum holdings. In the past, we talked about the option of selling excess spectrum, and that we had received bids from multiple parties. The AT&T/T-Mobile deal demonstrates the enormous value of our spectrum position. With the near-term capital needs of our current business now satisfied, we will be extremely judicious with our spectrum assets.”
Later in the call, you added:
“There are clearly buyers of spectrum; both strategic and speculative buyers. The speculative would fall into the private equity category. I think that we clearly look at that as an opportunity and a cost. I view that spectrum is, and continues to rise in value. Every time a kid downloads a video onto his phone or a company arranges for a conference call via their iPads, video conference via iPads, you’re in effect seeing the value of spectrum rise. And I think that it would be prudent for us to be in a position to hold that spectrum, all the spectrum, even that which is beyond what we immediately need.”
“I view that the spectrum sale is something that we certainly don’t have to consider in 2011.”
The market took this commentary to mean that the company would rather sell equity at depressed market prices or do another dilutive Exchange note placement (and increase Clearwire’s cash interest cost above $480 million a year), despite having ready bidders for spectrum.
We believe Clearwire’s spectrum has great value that is not reflected in the stock price. Our view, and the market’s view, is that selling equity at these levels (strategic or otherwise) would be extremely dilutive to your shareholders. At current market, the implied value of the spectrum is less than $0.20 per MHz/POP. Even the DBSD (old bankrupt ICO MSS) and TerreStar spectrum trade above Clearwire on an EV/MHz/POP basis today. We understand Clearwire’s view that strategic equity means a partner who brings something other than cash to Clearwire (e.g., network, subscribers, distribution). Yet whatever the partner brings will have an economic value, and it is hard for us to imagine a strategic partner contributing value at a rate that is above the cash trading price of Clearwire’s stock.
Perceived Conflicts of Interest
We also believe the failure to close the funding hole put Clearwire at a negotiating disadvantage vis-à-vis Sprint both for the wholesale pricing dispute and the network hosting deals Sprint is considering today. Specifically, had Clearwire sold $400 million of spectrum during 1Q, it could have applied the proceeds to the 2011 capital expenditures, as required by the credit agreements, and repositioned the cash raised in December for operational burn. The cash would have been fungible to that extent and may have led to a fully-funded business plan for 130 million POPs.
As things stand now, Sprint believes it is the only option for funding Clearwire, and so it can wait you out and name its price. In fairness, we also are critical of Sprint for squandering its lead in 4G and leaving the nationwide rollout half done. Having Clearwire’s fate tied to Sprint’s missteps has not been helpful. Still, even selling a small amount of spectrum would re-rate the stock and put a floor to the financial backstop to which you referred on the 1Q call.
And here’s the real conflict. Clearwire is critical to Sprint. Its best customers are on your network. It has no 4G offering without Clearwire. Yet Sprint does not need or want Clearwire to trade to $15 or $20 per share. Sprint believes its best play is to keep Clearwire depressed in value and cash-starved, which leaves Clearwire vulnerable to a cheap take-under. We happen to think this is not smart for Sprint: it delays the 4G rollout and means Sprint is likely to have to fund the network build one way or the other. We also believe the real negotiating leverage should work the opposite way: Clearwire has other strategic options; Sprint has no realistic replacement for your network and spectrum. Further, while Clearwire has apparently narrowed its options, Sprint has been on a PR roll about network hosting deals with other potential spectrum partners, like Lightsquared.
Whatever the negotiations are behind the scenes, Sprint has positioned Clearwire as the needy partner. Recent stock sales by other strategic investors only add to the pressure on the stock and reinforce that view. We are increasingly concerned that the economics in a network hosting deal would not favor Clearwire. We are also concerned that Sprint may attempt to structure the deal in such a way as to make Clearwire unattractive to other potential partners (e.g., Sprint simply leases the spectrum on an exclusive basis without subscriber or usage-based economics). This would effectively give Sprint an exclusive on a take-under of Clearwire in the future.
Sell-side analysts are coming to the view that Sprint holds the key to wholesale deals in the U.S. (see, e.g., Goldman Sachs, United Sates: Communications Services, May 17, 2011, “Sprint now in prime position as go-to wholesale partner.”). We find this view deeply troubling, because the large spectrum wholesale business is Clearwire’s business model, and the opportunities presented by spectrum shortages should benefit Clearwire, not Sprint.
As part of the public shareholder group, we would like to meet with you to expand on our views and suggest different courses of action for you and the Board, especially the non-Sprint designated directors, to consider. While we do not doubt your personal integrity, the fact that you are both a Sprint-designee and primarily responsible for negotiating any network hosting deal with Sprint may leave the process susceptible to criticism.
We believe you should continue to lead those negotiations but believe the non-Sprint designated directors should form a Negotiating Committee that would consult closely on the negotiations. At the same time, the Strategic Committee should continue to explore strategic alternatives to a Sprint deal, including selling excess spectrum at a premium to the value implied by Clearwire’s enterprise value. This will better assure that minority Clearwire shareholders maximize their value. We would expect this process to provide a measure against any Sprint deal, to make certain that the economics of a Sprint deal are the best result for shareholders, and ensure that if Sprint wants to assume control of Clearwire or its assets, Sprint pays the highest and best price.
I trust you will appreciate our directness in expressing our views in this letter. We expect to share our views with other public shareholders in the near future and wanted to have a discussion with you before moving in that direction. We look forward to speaking with you directly in the near future.
Very truly yours,
President and CIO
Cc: Board of Directors