Clearwire Crunched!

While the rest of the domestic equity world was enjoying a rare market rally on Tuesday, Clearwire LLC (Nasdaq: CLWR) was taking it on the nose to the tune of down 26 percent (at the time of this writing) on less than average volume. What’s the problem? Well, there are two issues at play here.

First, there was a downgrade of the stock from a buy to a sell rating by Stanford Research. The firm indicated that it has significant concerns regarding CLWRD's business model and cash burn as the economy continues to deteriorate.

Now the cynic in me would wonder just exactly what is different today relative to Clearwire’s business model and the economy from that of last week or last month. If anything, the business model has actually improved as the company has demonstrated improving cash flow from operations over the last three quarters. More importantly, it received an infusion of cash with the closure of the deal with Sprint.

The reality relative to the stock movement is that Clearwire does not generate a lot of trading volume. Consequently, moving the stock up or down generally doesn’t take a great deal of effort when a buyer or seller chooses to move quickly. If I were seeing the same decline on a multiple of average daily volume I would expect that there were quite a few investors who simply wanted out as quickly as possible. In this instance it appears that someone decided to exit their position and, lacking any buyers, the market-makers had to drop the bid rather dramatically to bring them out of the woodwork.

The second issue is one that has raised its head before and is something of a canard at this stage of the game. In actuality, it should not be an issue at this point.

Following the closure of the Sprint Nextel Corp. (NYSE: S) XOHM and Clearwire merger last week, the company held a conference call to discuss their plans with the media and analysts. Following that call, during an interview with Reuters, the company’s CEO Ben Wolff suggested that conditions in the credit markets could cause Clearwire to slow its planned rollout of mobile WiMax.

Back when Sprint and Clearwire announced their intentions to merge, they jointly outlined their plans to have a network in place by the end of 2010 that would cover a population area of 120 million to 140 million people with the objective of expanding it to more than 200 million at some period beyond 2010. Since networks don’t come for free, Clearwire will have to commence a fairly aggressive capital spending program. At the closing of the merger, Clearwire received an investment of $3.2 billion from five strategic investors: (Comcast Corp. (Nasdaq: CMCSA, CMCSK), Intel Corp. (Nasdaq: INTC), Google (Nasdaq: GOOG), Time Warner Cable Inc. (NYSE: TWC), and Bright House Networks ). However, that will still leave the company $2.0 billion to $2.3 billion short of its capital spending targets.

The concerns relative to credit availability have surfaced before (i.e., in October) and likely will surface again. However, what Mr. Wolff forgot to say is what he noted on a conference call last summer when specifically asked about the very same issue. If Clearwire did nothing, the $3.2 billion investment would last through mid 2010 and leave them with a network covering a population of approximately 110 million. That’s nearly the entire first phase in total so it’s obvious that the additional funding is necessary for the “beyond 2010” program.

The reality is that by the time additional capital is needed, the company should have been able to demonstrate the viability of its business model just as it did for the “old” Clearwire via the improving margin metrics of its original 25 markets. As you can see in the graph below, over the last five quarters those original 25 markets have seen their gross margin remain steady, but their EBITDA margin (earnings before interest, taxes, depreciation and amortization) increases dramatically. Of equal importance is that all 25 are cash flow positive.

Clearwire: Initial 25 markets

The successful demonstration of its business plan in 2009 may well make any offering much more attractive to potential investors or lenders. In reality, no one knows what our credit markets will look like a year or two down the road from now anymore than they knew a few months ago where we would be today. The bigger issue is that if we haven’t resolved our credit issues by 2010, we’ll have far more important problems to deal with at that point than Clearwire.

From an investment perspective there is only one thing that I want to see and that is Clearwire’s management team executing to the plan that they have laid out in the past. Management has commented for sometime that it wanted to hit the ground running and a quick scan of their job postings suggests that that is exactly the case. A number of weeks ago I highlighted to subscribers of The Telecom Connection that Clearwire was searching for network implementation staff in Dallas, Denver, Houston, Los Angeles, Miami, San Antonio, and San Francisco. That list has since expanded to include:

Austin, Texas
Orange County, Calif.
Baltimore and Washington
Orlando, Fla.
Boise, Idaho
Oxnard, Calif.
Boston and Rhode Island
Philadelphia
Chicago and Wisconsin
Phoenix
Cleveland
Pittsburgh
Colorado Springs, Colo.
Riverside, Calif.
Connecticut
Sacramento, Calif.
Detroit
Salt Lake City
Fresno, Calif.
San Jose, Calif.
Jacksonville, Fla.
Spokane, Wash.
Lakeland, Fla.
Stockton, Calif.
Minnesota
Tacoma, Wash.
New Jersey
Tampa, Fla.
New York City
Tennessee
North Carolina
Western Pennsylvania and New York
Ohio-Kentucky-Indiana
West Palm Beach, Fla.

Obviously, they weren’t kidding!

From where I sit, this is much to do about nothing, and courtesy of one sell-side firm or a worried investor, the stock is far less expensive than it was on the previous day. It’s certainly a speculative stock, not for the faint of heart or those looking for the quick buck. But when you consider the fact that the company’s partners invested based upon valuations in the $17- to $23-per-share range, current buyers on the open market are being given a huge discount. We’ll have to wait and see if that plays out in the longer term.

Position: The Telecom Connection model portfolio is long CLWRD

Clearwire is one of the many technology and telecom companies that Bob Faulkner writes about weekly in The Telecom Connection.