Leap Wireless International Inc (LEAP)
Action — We expect Leap to report 1Q results on Wed., 5/4, after the market closes with a conf. call scheduled for 5:00 PM ET. We remain buyers of Leap and continue to believe Leap should benefit from: 1) rising Smartphone penetration that should lead improving wireless revenue growth; 2) improving its wireless OIBDA margin later in 2011, as the company digests higher equipment replacement costs through 1Q/11; and 3) trading at a meaningful discount on implied spectrum values (at $0.74/Mhz/POP vs. PCS at $2.23/MHz/POP). We believe the prospects for ARPU growth to continue over the next few quarters can offset the historical headwinds the share price has faced during the next six months of seasonally slower subscriber growth.
Preview of 1Q Results — Leap pre-released better 1Q subscriber metrics highlighted by better net adds of 300k vs. our estimate of 300k on churn of “lower than 3.5%” vs. our original estimate of 3.5%. ARPU was pre-released as “higher than 4Q/10” levels of $37.13 and $38.14, respectively, vs. our $39.48 est. We forecast revenue growth of15.6% yoy to $761.6 mil. vs. consensus of $737.7 mil. Leap expects adjusted OIBDA to reflect “strong 1Q customer activity,” and we currently estimate OIBDA of $118.5 mil. vs. a consensus of $109.6 mil. We forecast EPS of ($1.17) vs. consensus of ($1.06).
Key Areas to Explore — 1) Increased customer activity and the correlation to OIBDA margin; 2) sustainability of subscriber growth and mix of subscriber additions adopting higher priced smartphone rate plans; 3) impact from ongoing competition; 4) update on 4G roaming deal with LightSquared; 5) increasing smart phone penetration and the effect on ARPUD & OIBDA; & 6) outlook for 2H11 LTE rollout.
Risks for the shares include potential for weaker-than-expected results during the seasonally stronger first quarter resulting in further competition and potential price changes. Other risks include the absence of a merger scenario, and dilution to cash flow levels from either greater price-based competition or extended unemployment rates in its markets.
Risks We believe the combination of rising Smartphone penetration and prospective industry consolidation should reduce the risk to Leap's ARPU over the near- and medium-term. We believe investor sentiment is likely to improve around the sustainability of Leap's business model in addition to the support value for their spectrum holdings. However, rising smartphone penetration means increased replacement and upgrade costs, which has the potential to lower margins over time. Citibank believes the absence of better visibility on seasonality or operating trends from management could add to share price volatility and recognize the absence of positive free cash flow for FY11 could further dilute the valuation from the current level.
If smartphone penetration continues to rise, the Leap may need to additional spectrum which may be difficult to obtain given scarcity or financial challenges. Changing subscriber economics could affect Leap's ability to meet our cash flow estimates and leave it over- or under-funded; while focus on younger-age demographics and budget-conscious segments should help insulate growth in a maturing wireless market.
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