Music to a bondholder’s ears

I own some long term debt in Sprint. Recently, the following was quoted from their CFO:

NEW YORK (AP) — Shares of Sprint Nextel Corp. rose Monday after Chief Financial Officer Bob Brust told investors the telecommunications company plans to pay down its debt and continue to strengthen its balance sheet.

“(In) the next 30 months, we have about $5.2 billion of debt coming due. Right now we plan to pay that as due, not refinance,” said Brust at the Raymond James Institutional Investors Conference, according to a transcript.

The only other better news that could come out of his mouth was that they would be raising capital through the equity markets to pay down more debt, but I will settle with this. Sprint has negative net income, but they have strong positive cash flows, and I think their debt is still (slightly) undervalued. It is my second largest portfolio component.

The only issue I have with their debt is not their ability to pay it off – it is the more macroeconomic perspective of rising interest rates and a US government that is seemingly destined to inflate its way out of its fiscal situation.

Knowing the difference between cash and income

One of the most powerful concepts that most beginning investors confuse is the concept of cash flow, and the concept of net income. In capital-intensive industries, an investor must know enough about the underlying accounting in order to make a proper investment decision.

Probably one of the easiest textbook cases for this concept is looking at the year-end report for Sprint Nextel Corporation. For 2009, they reported a net loss of $2.44 billion, but generated about $2.7 billion in cash at the end of the day.

The simple reason for this is that the company made huge investments in telecommunication assets in prior years and is continuing to depreciate those assets – the actual cash has been long since paid and as such, the depreciation expense does not represent a cash transaction.

So while Sprint will be reporting net losses for the foreseeable future, the company will still be generating cash to pay off its debt. Eventually this process will stop when the assets have been further depreciated, but it is up to an investment analysis to decide whether the company will put more cash into more capital projects, or whether to milk their existing investments and just spend money on maintenance.

Telecommunication companies, in this respect, are relatively easy to analyze.

Finally, as a bondholder in Sprint, all I am concerned about is their ability to service debt. The company does not pay a dividend and at the rate they are able to generate cash, will be able to service their debt for the foreseeable future. Back in October 2008 and March 2009, I was busy picking up equivalent units of debt that will continue to give off insane returns on investment (averaging roughly 18% in coupon payments and 5% in annualized capital gains upon maturity). There is no chance that equity will be able to repeat this at the risk I am taking!

Even today, such units are trading at about a 9.3% current yield, and about 1.9% capital growth to maturity, which is likely better than what you would get from equity over the next 19 years.