Sprint's World of Pain

Shares sank after CEO Daniel Hesse candidly admitted the telecom's troubles were far from over

Daniel Hesse's coming-out party was anything but festive.

Two months into his new job as chief executive of the troubled wireless operator Sprint Nextel (S), Hesse oversaw his first quarterly earnings report and analyst call. His message was as blunt and depressing as a Sylvia Plath poem: A turnaround of the No. 3 U.S. wireless operator is not going to happen any time soon. "I now have had two full months at the helm, and to be perfectly frank, the issues we face are more difficult than what I had expected to find," Hesse said on a Feb. 28 conference call following yet another dismal quarter. "This turnaround will not happen for many quarters." Sprint shares fell more than 10%, to close at 8.03, a new 52-week low. The last time Sprint touched $8 was in February, 1989.

There was so much bad news it's hard to know where to begin. Customers, fed up with horrible customer service, continue to flee Sprint in droves. The company confirmed a staggering $29.7 billion writedown, wiping out nearly all of the value of its $35 billion merger with Nextel Communications. And dividend payments were suspended "for the foreseeable future."

Ratings Downgraded on Bad News

But that's not all. Among premium subscribers, churn—a key metric measuring the percentage of customers who leave the company—was flat at 2.3%, despite intense efforts by Sprint to reduce the figure. Interim Chief Financial Officer William Arendt said the company expects churn to increase 0.2% to 0.3% in the first quarter "due to competitive pressures" and rising defections among lower-credit customers. Customers that are staying with Sprint are spending less money, with the average revenue per customer declining 4% over the year-ago quarter. And, to top it all off, Sprint announced it has borrowed $2.5 billion from its revolving credit facility to help pay off $2.25 billion in bonds that will mature in 2008 and 2009.

"This was an opportunity for Hesse to throw out everything including the kitchen sink and he did," says James Moorman, an analyst with Standard & Poor's. "Rebuilding your image does not happen overnight. It will be tough for a while."

Fitch Ratings promptly cut its rating on Sprint Nextel to junk status and warned that it may cut the rating again since 2008 results will be significantly worse than expected. S&P said it may cut Sprint's ratings to junk. "The erosion in Sprint Nextel's subscriber base and the resultant decline in EBITDA are substantially higher than we anticipated and the company's business profile is probably no longer supportive of an investment-grade rating," S&P credit analyst Allyn Arden said in a Feb. 28 statement.

Reviving Customer Service

The core challenge for Hesse will be to repair Sprint's damaged reputation and convince customers to give the company another chance. In the fourth quarter of 2007, Sprint reported a loss of 683,000 premium subscribers who sign up for long-term contracts. In that same quarter Verizon added 2 million customers, including 1.6 million post-paid subscriptions, and AT&T added 2.7 million customers, including 1.2 million post-paid subscriptions. The customer service problems are so pervasive that Hesse said the company expects to lose another 1.2 million premium subscribers in the first quarter of 2008, and that the outlook was unlikely to improve in the second quarter.

To slow customer defections, Sprint announced a new service plan for $99.99 a month that offers unlimited calling and data plans, including unlimited text, video, and picture messaging. Rivals Verizon Wireless (a partnership between Verizon Communications (VZ) and Vodafone (VOD)) and AT&T (T) recently rolled out similar plans, which included only unlimited calling. T-Mobile has unveiled an unlimited calling and data plan for the same price. "We are putting a flag into the ground that we intend to own the data world going forward," says Hesse. "It won't turn the ship around right away but it begins to get us on the path."

Hesse says his turnaround plan hinges on improving the customer experience. Customer service experts and business professors say Sprint has focused too much on productivity and sales growth rather than quality service. Call center reps say a numbers-driven management approach implemented after the merger has led to poor morale among employees, whose bathroom trips are even monitored, and poor service. "If your lack of trust in employees is so low that you are monitoring their bathroom breaks, you are guaranteed to have customer service problems and huge employee morale issues," says Vijay Mehotra, an assistant professor at San Francisco State University who has studied call centers extensively.

Cutting Errors and Adding Products

Hesse, an industry veteran who once ran AT&T Wireless, revealed details of his plans to BusinessWeek last week, but Hesse and Chief Service Officer Bob Johnson announced some other new efforts. First, the company is trying to slash the reasons that customers call Sprint in the first place, by reducing, for instance, billing errors. To achieve a consistent level of quality service in its call centers, Johnson said the company is standardizing its contracts with call center outsourcers and putting a new emphasis on resolving customer problems on the first call.

Some analysts have called for the breakup of Sprint and Nextel. But Hesse downplayed that idea by announcing new plans to promote Nextel's iDEN "push-to-talk" service. Chief among them: Sprint this year will roll out a push-to-talk service on its CDMA network, as well as introducing new handsets such as an iDEN Blackberry device. "We believe [iDEN] can be better utilized at present," said Hesse.

One other option that may fly is to spin off its WiMax division that offers wireless broadband services. Last November, Sprint terminated a letter of intent with wireless broadband provider Clearwire (CLWR). On the fourth-quarter conference call, the company said it continues to have discussions with Clearwire "on potential relationships, but no final agreements have been reached." But it declined to offer specifics. Some analysts speculate that Sprint could form a partnership with Clearwire and other tech companies such as Intel (INTC) or Google (GOOG). Other analysts think a spin-off would help Hesse repair Sprint's core wireless business. "I wouldn't mind seeing them spin it off," says S&P's Moorman. "It would allow Hesse to focus more on their subscriber base."

As Hesse tries to fix Sprint, perhaps the toughest turnaround in Corporate America, his honesty may be his greatest asset. "Our business is not performing well right now because we have not provided the right customer experience," Hesse said in concluding his prepared remarks. "We are working aggressively to turn this around, but our financial performance will not improve overnight." Until then, there won't be much to celebrate.

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