Leap Wireless to Underperform - Analyst Blog

We downgrade our recommendation on Leap Wireless International Inc. (LEAP) to Underperform. In the last three consecutive quarters, the company suffered a net subscriber loss contrary to the consensus opinion of a net subscriber addition. Important operating metrics such as ARPU, churn rate, customer addition cost deteriorated significantly.

Despite Leap Wireless' announcement of net customer addition in the fourth quarter of 2010, the extent of growth was way below the prior-year level. In fact the company lost 48,000 broadband customers in the last quarter.

Leap Wireless is operating in an intensely competitive, domestic, low-cost prepaid wireless market. As the prepaid wireless market is heating up, the company's peers like Metro PCS Communications Inc. (PCS), Boost Mobile, a subsidiary of Sprint Nextel Corp. (S), and Tracfone, a subsidiary of America Movil SAB (AMX), are winning an edge over Leap Wireless with their competitive service plans, greater network coverage and better product offerings, thus luring away subscribers.

We are also concerned about the company's significant balance sheet leverage, reflected by a high debt-to-capitalization ratio of 0.71. At the end of the third quarter of 2010, Leap Wireless' total debt was approximately $2.74 billion, connoting significant interest burden.

This substantial indebtedness will limit the company's ability to raise funds to support the ongoing expansion initiatives into new markets that entail greater operating and capital expenditure on infrastructural build-outs.

Leap Wireless provided a disappointing future financial outlook. This is mainly due to the ongoing business transformation process undertaken by management.

The company has taken a series of new measures including shifting to all-inclusive cell phone service plans, elimination of reactivation fees and other fees, change in dealer compensation policy, and the introduction of new smart phones. Unfortunately, so many strategic changes have resulted in execution problems, not delivering any fruitful result.