Difficulties surrounding a 2005 merger, and the ensuing 2007-2009 recession, hobbled Sprint Nextel’s (S) operating performance. Investors fled the stock, leading to a share price below $2 in 2009, versus a 2005 high of $27. A new CEO, Daniel Hesse, was called upon to turn things around. He has endeavored to improve service, enhance network quality and introduce attractive products and offerings to rebuild the customer base and revenue and earnings. Competition is fierce, but we believe that patient, risk-tolerant investors stand to gain over the pull to 2013-2015.

In August 2005, Sprint Corp. finalized its merger with Nextel Communications in a $35-billion, cash-and-stock transaction. Management had high hopes for the new company, Sprint Nextel. Nextel added 15 million wireless subscribers to Sprint’s 20-million base, and boosted both that telco’s annual revenue and operating income by about 50%, excluding wireline operations, which were spun off to shareholders. Nextel contributed a good revenue-generating, push-to-talk service popular with small businesses. Potential operating synergies were estimated to be $12 billion.

Unfortunately, the integration of Sprint and Nextel did not pan out well. Service quality suffered, and customers went elsewhere, with AT&T (T – Free AT&T Stock Report) and Verizon Wireless, a Verizon Communications (VZ – Free Verizon Stock Report)/Vodafone (VOD) partnership, being the prime beneficiaries. Exacerbating the situation was a weak lineup of phones. Too, exercising certain agreement rights, a number of affiliates forced Sprint Nextel to buy them out for several billion dollars, straining finances. The telco’s struggles resulted in the departure of top executives.

Around the end of 2007, Dan Hesse, the former CEO of Sprint’s wireline division Embarq, assumed the company’s top job. His effort to reinforce the brand name and reverse subscriber losses began to show success in 2010. Net account additions turned positive in the June quarter, supported by Sprint brand postpaid and multibrand prepaid wireless growth. The de-emphasized Nextel brand continued to lose customers.

This year, we expect a modest revenue gain and a narrowing of share-net losses. Importantly, the telecom has started a $5-billion, four-year program to consolidate Nextel’s iDEN (integrated Digital Enhanced Network) system with the legacy Sprint CDMA (Code Division Multiple Access) network, which may well yield $10 billion-$11 billion in cost savings over a seven-year period. We look for Sprint Nextel to earn a net profit within the next 3 to 5 years.

Bolstered by the November 2009 acquisition of resale partner Virgin Mobile, the prepaid division is allowing the company to rebuild its account base. Thanks to its national, physical network, Sprint Nextel can offer unlimited service in this segment at a higher, but still appealing, price point, compared to those of competitors MetroPCS (PCS) and Leap Wireless (LEAP), which rely on roaming to offer broad market coverage. Notably, cable partners are beginning to provide a nice lift to prepaid wholesale results.

Crucial to Sprint Nextel’s future success is its ability to strengthen the postpaid business. Advanced devices, including HTC Corp.’s Evo Shift 4G smartphone and Research in Motion’s (RIMM) Blackberry Playbook tablet, will help the telco to compete against AT&T and Verizon Wireless, which offer the popular Apple (AAPL) iPhone. The Google (GOOG) Android operating system is gaining a wide following, eating into iPhone market share. We believe that, with its substantial wireless spectrum and partnership with Clearwire (CLWR), Sprint will be able to maintain good service quality and compete against its rivals, which may suffer capacity constraints.

Clearwire is helping Sprint to deliver national, fourth-generation (4G) WiMax (Worldwide interoperability for Microwave access) mobile broadband service. The two companies currently have a lead over AT&T, Verizon Wireless and T-Mobile USA, a Deutsche Telekom (DT) subsidiary, in delivering 4G services, but these telcos will quickly close the gap with LTE (Long-Term Evolution) and HSDPA (High-Speed Downlink Packet Access) offerings, beginning this year. Clearwire is leaving open the option to utilize LTE.

After recovering some lost ground, the share prices of both Sprint and Clearwire have traded in a low, narrow, share-price band over the past year. Investors are concerned that Clearwire will have problems financing the $3-billion second stage of its national network buildout, requiring a greater commitment from Sprint, which has about a 54% stake in the company. This issue soon may be resolved, however.

Late last year, Clearwire issued $1.3 billion in new debt and said that it was considering as much as a $2-billion auction of excess spectrum. (T-Mobile might be a buyer of the spectrum.) Furthermore, management is seeking additional investment from a new partner, or existing ones, Comcast (CMCSK), Time Warner (TWX), Intel (INTC – Free Intel Stock Report) and Google among them. Recently, Craig McCaw resigned as Co-Chairman of Clearwire, sparking rumors that a funding deal was close at hand. (Not long ago, Sprint secured a pact with Clearwire, enabling the telco to cut its voting rights in that company and, thereby, eliminate cross-default risk.)

Price competition and mobile device subsidies pressure Sprint’s margins, as they do those of competitors. In the years ahead, though, high data usage, the imposition of surcharges, and wider adoption of tiered plans should keep pricing levels reasonable. Too, as the population of smartphones increases, prices, and subsidies, should continue to fall, shoring up profitability. A plus for Sprint is that the Android operating system entails lower expenses than that of the main alternative device, the iPhone.

True, Sprint’s finances are rather stressed, as evidenced by a sizable debt obligation, but management has prudently set aside cash, over $4 billion, to meet upcoming debt maturities. The telco is striving to lift cash flow to adequately fund operations and ease its financial burden.

There are still considerable financial, operating and competitive risks surrounding Sprint Nextel. Even so, in our view, these risks are largely factored into the equity’s recent valuation (near $4.50 a share). Venturesome investors with a view to 2013-2015 should be well rewarded if Sprint is successful; we believe the telco stands a fairly good chance of being so.

At the time of this writing, the author did not have positions in any of the companies mentioned.