In the world of high-speed wireless technology, known as 4G, you can bet on two horses: WiMax, which is a long-distance version of Wi-Fi, or LTE, which stands for Long-Term Evolution. Sprint (NYSE: S) has staked its fortunes on WiMax, and has an early head start, while Verizon Wireless (NYSE: VZ) and AT&T (NYSE: T) are expected to roll out LTE later this year and into 2011.
Sprint made that WiMax bet after becoming a major shareholder in Clearwire (Nasdaq: CLWR), a pure-play high-speed wireless provider in the process of rolling out service in major American cities. Trouble is, Clearwire just announced it is having second thoughts. Perhaps LTE is indeed a solid choice after all, mused company CEO Bill Morrow on a conference call with investors Wednesday night. He conceded what many industry watchers already knew: that LTE is capable of carrying much higher volumes of high-speed data than WiMax. That's bit hard to swallow for investors, as Clearwire has already consumed massive amounts of capital with its WiMax bet.
More customers = more losses
Clearwire has been an impressive growth story -- as long as you ignore the rest of the company's income statement. In the second quarter, the company added more than 700,000 net subscribers, and now has around 1.7 million in the fold. That led to a +93% spike in revenue from a year ago. Strong growth should continue as Clearwire expands into new cities.
Yet all those new subscribers aren't helping the company break even. Clearwire has now lost about -$0.50 a share in each of the past four quarters is expected to lose money at that pace at least through 2011. In fact, the company's EBITDA losses are on track to rise for the sixth straight year, and will likely exceed $1 billion.
Stubbornly high operating losses coupled with the money needed to expand into new cities and perhaps even shift technologies will of course lead to new sources of funding. Clearwire is expected to spend $3 billion just this year and is on pace to run through its current cash balance by early 2011. UBS believes an additional $3 billion will need to be raised. If the company simply sold stock to raise that money, it would need to issue more than 400 million shares, effectively tripling the share count.
Actual dilution will likely be somewhat less as the company can try to borrow more funds, but with $2.7 billion in long-term debt already on the books, there are limits to how much more debt it can take on. As it stands, Clearwire is paying double-digit interest rates on its debt, highlighting the very risky nature of this underfunded business model. Existing debt covenants imply that Clearwire would need to raise $2 in stock for every additional dollar it borrows. So that may work out to $2 billion more in stock sales and $1 billion more in debt. It's unclear whether the company will find demand for all those shares, which means it'll likely have to sell them at a discount. That's one of several reasons why shares are ripe as a short candidate. That would lead to nearly 300 million shares being issued, more than doubling the current share count.
Management could also look to sell off some of the wireless spectrum the company owns, but that would diminish any long-term potential the company may have.
Deceivingly robust ARPU
Clearwire derives more than $40 in average revenue per user (ARPU), but the company hasn't really seen any major competition for its wireless broadband services yet. What happens when companies like AT&T and Verizon enter the market? If history is any guide, they'll try to steal Clearwire's thunder by undercutting it on price. In a battle for market share, price wars inevitably ensue once market shares have been established. Since AT&T and Verizon Wireless do not want to lose any customers, you can be sure that market share rather than peak prices will be a priority.
Playing chicken with Sprint
Clearwire's willingness to embrace LTE is also seen as a bid to find other partners such as T-Mobile that cannot migrate to WiMax. Trouble is, Sprint has an option to boost its stake in Clearwire and could then veto such a move. Clearwire is playing a game of chicken that could well backfire.
Action to Take --> Wall Street loves Clearwire, as it continually needs bankers to raise more money. But it's increasingly clear that the company's never-ending dilution, technology zigzags and competitive positioning vis-a-vis Verizon Wireless and AT&T Wireless has turned this into a very risky story. Investors looking to add shorts to their portfolio should give this stock a close look.