We are long Sprint Nextel Corporation (S) and have published numerous reports on the company due to its progress in establishing itself as a viable alternative to AT&T (T) and Verizon (VZ). Sprint's recent strategic corporate transactions with SoftBank (OTC:SFTBF) and U.S. Cellular (USM) made us think back to two of our September reports on Sprint. In our September 17th report, we discussed in our telecommunications industry outlook section that we saw Sprint as a potential acquisition target for a foreign telecommunications company that would want access to the highly lucrative US mobile communications market. We were actually disappointed that Sprint agreed to sell out 70% of the company to SoftBank for $20.1B in a combination of cash, debt and stock because we felt that Sprint had made enough progress on its own without having to sell out. Furthermore, we felt that if Sprint had to sell out, we would have preferred to have sold out to CenturyLink (CTL), which acquired its spun-off local telephone operations. Four days later, we published our evaluation of Sprint's performance at the annual Goldman Sachs Communicopia event. We discussed how Sprint was enjoying strong iPhone 5 sales volumes and that the three companies that Sprint should consider acquiring were U.S. Cellular, Leap Wireless and MetroPCS. Less than two months after we published that report, Sprint agreed to acquire U.S. Cellular's Midwestern Operations for $480M.
Before MetroPCS merged with T-Mobile USA, we were in agreement with other investors that Sprint should acquire MetroPCS and Leap Wireless (assuming a rational and reasonable price) in order to strengthen its leadership position in the prepaid segment. Sprint had more prepaid customers than the AT&T/Verizon duopoly and Sprint's prepaid customer base is bigger than T-Mobile USA and MetroPCS combined. However, we believe we were the only ones who suggested that Sprint acquire U.S. Cellular. While Sprint did not acquire U.S. Cellular outright, Sprint acquired 10% of U.S. Cellular's customer base. Sprint acquired U.S. Cellular's Midwest operations in Ohio, Michigan, Indiana, Chicagoland, Central Illinois and St. Louis. The deal will transfer spectrum and about 585K customers from U.S. Cellular to Sprint. The markets accounted for 11 percent of U.S. Cellular's service-related revenues through the first nine months of the year. After the sale closes, the company will have more than 5.2 million customers in 23 states. In Illinois, the carrier's remaining markets include Joliet and Rockford. Although U.S. Cellular was a seller of assets, its shares have suffered a larger decline since the sale was announced in relation to Sprint.
Source: Morningstar Direct
The reason why we had a greater interest in seeing Sprint acquire U.S. Cellular in whole or even in part versus T-Mobile USA was while T-Mobile USA had significantly more customers than U.S. Cellular, T-Mobile USA was on a different communications network than U.S. Cellular. T-Mobile USA utilized the GSM mobile communications network standards while Sprint utilized CDMA. We can't help but remember back in 2005 when Sprint acquired Nextel Communications. Sprint was on the CDMA mobile communications network standard and Nextel utilized an old, archaic 2G standard called iDEN. Needless to say, Sprint's acquisition of Nextel has qualified for a place in the Deal From Hell Hall of Fame as Sprint wrote off nearly $30B in 2007 of its $36B purchase and fired its old CEO Gary Forsee. We can see that Gary Forsee couldn't foresee what would happen if he spent $36B to acquire a company with an archaic and incompatible mobile communications network standard.
Another reason why we were interested in seeing Sprint acquire U.S. Cellular versus T-Mobile USA was because U.S. Cellular had seen less postpaid customer defections than T-Mobile USA due to a lower churn rate. T-Mobile has seen its postpaid customer base steadily erode by about 10% since 2010 while U.S. Cellular has seen its postpaid customer base decline by 4.45%. U.S. Cellular's postpaid churn rate has been consistently between 1.5%-1.6% during this time period while T-Mobile's postpaid churn rate has been consistently well above 2% during this time period. Although the markets that Sprint is buying from U.S. Cellular have churn rates of 2.8% in the first nine months of 2012, we believe that Sprint will be able to improve this significantly because Sprint's customer service experience has improved under Dan Hesse's leadership and is running neck and neck with Verizon Wireless. Sprint also has the iPhone whereas U.S. Cellular did not.
Source: 2010 Annual Reports and 2012 Q3 Earnings Releases for U.S. Cellular and T-Mobile USA
The reason why we were interested in seeing Sprint acquire U.S. Cellular before Leap Wireless or MetroPCS was due to the different customer bases of each potential target firm. The customer bases of Leap Wireless and MetroPCS are 100% prepaid while U.S. Cellular's customer base is nearly 90% postpaid. Sprint's biggest need is to bulk up in its postpaid operations because Sprint is a distant #3 to the AT&T/Verizon duopoly. Although Sprint offers the best value for postpaid wireless service with regards to the Big Four national carriers, U.S. Cellular's postpaid plan consisting of 450 anytime minutes, texting and 2GB of data costs $74.99/month, versus $79.99/month for Sprint's unlimited data and texting with 450 anytime minutes.
In conclusion, we believe that Sprint did not need Softbank to come in and acquire 70% of the company for it to be a stronger company than T-Mobile, even though T-Mobile recently announced that it was merging with MetroPCS. We maintain that Sprint had been positioning itself to potentially provide headwinds to growth for the AT&T/Verizon wireless business and we would have preferred to see an independent Sprint continue this journey rather than take the Roy Raymond route of selling out. At the same time, Sprint's strategic corporate transactions over the last two months have validated our previous research that Sprint is the best value for the consumer and the best value for the investor. Sprint's recent strategic corporate transactions have also validated our thesis that Sprint would be a desirable takeout target for a large foreign communications firm as well as a potential acquirer of smaller wireless telecom players.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.