Sprint's (NYSE:S) recent bid to purchase the rest of Clearwire (CLWR) at $2.90 per share has met with resistance from minority shareholders Mount Kellett Capital and Crest Financial. This doesn't surprise me at all because I think the offer is much below Clearwire's actual value. I also believe that this is exactly the reason why Clearwire is trading above the buyout price.
Companies are acquired for a variety of reasons, some ostensible, some not very. When SoftBank offered to buy 70% of Sprint, the ostensible reason appeared to be that the Japanese company wanted to enter the U.S. market through the country' third largest carrier after Verizon (NYSE:VZ) and AT&T (NYSE:T). The not so ostensible reason, as I described in another article, was Clearwire's licensed spectrum. Sprint was a large stakeholder (almost 50%) in the company even though Mr. Hesse, CEO of Sprint, insisted that Clearwire was not even part of the picture. I thought otherwise in that article. I was correct. The full picture revealed itself this week with Sprint seeking to acquire the rest of 485 of Clearwire that it does not own.
But is it a good deal for minority shareholders who own a substantial chunk of Clearwire common stock and for retail investors who believed in the strength of the company's spectrum position?
Does Pricing of the Offer Reflect Clearwire's Real Value
Spectrum is a finite wealth, and as such, companies like Verizon and AT&T are constantly seeking to acquire it in order to provide better services to their ever-growing subscribers. About fifteen months ago Verizon announced that it was acquiring wireless spectrum from Spectrum Co, a consortium of cable companies, for $3.6 billion at $0.68 per MHz-Pop (a measure of the number of people covered by each megahertz of spectrum.). The price that Verizon paid was almost 50% more than the $0.45 that Spectrum Co paid in the FCC auction way back in 2006.
The price of spectrum continues to grow as it has for the last so many years. Like real estate, it is a scarce resource and there is only a fixed amount of it available but unlike real estate, its value is not cyclic in nature. Even if we calculate on the basis of the same price ($0.68) that Verizon agreed to pay then to Spectrum Co, Clearwire's spectrum position of approximately 46 billion MHz-Pops gives it an enterprise value of more than $31 billion. That calculates as $30 per share. (In these calculations, I have received considerable help from SR Capital's excellent article).
At the same time, performance of CLWR stock also does not reflect its true value. The stock has been languishing between $1 and $2 till the time SoftBank's offer was announced. $2 per share puts the value of Clearwire's spectrum position at $0.13 per MHZ-Pop. Sprint's offer of $2.1 billion for the rest of 48% values the company at approximately $4.38 billion or roughly $ 0.19 per MHz-Pop.
The issue of valuation also cropped up after SoftBank's offer. Sprint was not in full control of Clearwire's spectrum position, something that was corrected by Sprint acquiring Craig McCaw's Eagle River Holdings' stake in Clearwire. The deal gave Sprint 50.8% ownership of Clearwire and put Sprint in the driver's seat for gaining control over the company's spectrum assets. It is interesting speculating Craig McCaw's constructive role in all these affairs.
Anyway, at that point the price ($2.97 per share) that Sprint paid to Eagle River appeared to be a decent price considering that CLWR had been trading between $1 and $2 for most of the year. Sprint had also approached Intel and Comcast and offered to buy their stakes as well. While McCaw's Eagle River Holdings was Clearwire's founder, long before any systems were built, Comcast (NASDAQ:CMCSA), Intel (NASDAQ:INTC), Times Warner Cable (NYSE:TWC), Google (NASDAQ:GOOG) and Brightpoint (NASDAQ:CELL) became Clearwire's partners by investing in the company at $17 per share.
However, the Eagle River deal brought a severe response within days of the transaction, which occurred in mid October 2012, from Mount Kellett Capital, a 7.3% stakeholder, who issued a letter to the board of directors expressing concerns over the deal. The full text of the letter is available here. After closure of the Eagle River deal, Crest Financial, another minority shareholder, lodged a complaint in Delaware Chancery Court in Wilmington, accusing the parties involved of robbing minority shareholders the gain that Sprint was unduly deriving from Clearwire's spectrum position.
The fact of the matter is that Sprint has been treating Clearwire (or rather, its minority shareholders, because in many ways, Sprint is Clearwire) roughshod despite the fact that it is dependent upon Clearwire's spectrum assets. Sprint not only owns approximately 50% of Clearwire, it is also its largest customer. Clearwire has a very strong spectrum position, far stronger than any wireless operator in the U.S. and with smartphones and tablets fast replacing PCs, spectrum is the key to the ever-increasing demand for wireless bandwidth. The reason that Sprint can afford to do this is that Clearwire has three major problems at hand:
- It is short on cash. The financial statement for the quarter ending September 30, 2012 shows cash and short term investments and accounts receivable at $1.24 billion. The company needs another $300 million before year end just to avoid running out of cash.
- It needs fresh funding to the tune of $1 billion for its build out program to be able to changeover from the out-dated WiMAX technology and move over to newer and the industry standard 4G-LTE network, which offers higher speeds on cellular broadband.
- It has a long term debt of over $4 billion.
The company has to try hard to just avoid bankruptcy and it is this that Sprint is trying to take advantage of. As part of the deal, Sprint has offered a monthly funding plan to the tune of $800 million, in lieu of Class B shares, and the payments start only after the current acquisition offer is approved by Clearwire's shareholders.
All said and done and despite Clearwire's problems, its spectrum position has a much bigger value than is reflected by the $2.90-price (with a cap of $2.97) that Sprint is offering to minority shareholders.
The Road Ahead
The moot point is that at least 24.8% of Clearwire's shareholders, other than Sprint, must approve the deal before Sprint can acquire the rest of the company. At forefront of the battle against Sprint's acquisition are Clearwire's minority shareholders, Mount Kellet Capital and Crest Financials, which says it holds 6.6% of Class A shares.
The main contention of the minority shareholders is that the board of directors is failing in its fiduciary duty towards other shareholders as it was more inclined towards Sprint's (majority shareholder in Clearwire) acquisition of Clearwire even if it was at a price that reflects the company's distress and not the full value that shareholders could get if the company's build-out is either finished or appears to be on the road to completion. The distress referred to is the funding gap of approximately $1 billion in Clearwire's build-out program and servicing of Clearwire's long-term debt obligations.
Crest financials, a Houston based company, said in a statement after Sprint's offer to acquire Clearwire that, "Today is the capstone in Sprint's ongoing effort to interfere with Clearwire's ability to operate as an independent company, to thwart the planned development of Clearwire's network, and to take Clearwire's valuable high-speed broadband spectrum for itself to the detriment of Clearwire's minority shareholders." The SoftBank-Sprint deal is still pending and Crest is seeking to block it and collect damages.
The Real Value of Clearwire
Spectrum is an asset and a scarce one at that. Just like any other asset, its value is determined by what the market (in this case, wireless carriers and financial players) is ready to pay for it. The market believes that the demand for wireless bandwidth is growing at a rapid pace. Cisco's bandwidth demand forecast, which is relied upon by most industry analysts, reveals that mobile data traffic "grew 2.3-fold in 2011, more than doubling for the fourth year in a row" and "By the end of 2012, the number of mobile-connected devices will exceed the number of people on earth, and by 2016 there will be 1.4 mobile devices per capita."
The low 2.5 GHz frequency controlled by Clearwire is particularly suited for 4 G LTE TDD cellular technology towards which the world is evolving and the technology that SoftBank uses in Japan. Also, data travels faster on low frequencies, the reason why low spectrum bands fetch a better price than higher frequencies.
According to a report appearing in Reuters, some minority shareholders are saying that Sprint should at least raise the bid to $5 per share. There are also other reports suggesting that $8 is a fair price, as a structured sale of Clearwire's spectrum assets can fetch that much per share.
It now depends upon Clearwire's management which way it wants to go - sellout minority shareholders or explore other alternatives. It could go for raising fresh equity, which should not be difficult considering that there are already some minority shareholders who would be interested despite dilution.
On the other hand, much depends upon whether those who have taken up cudgels against the management (Mount Kellet and Crest Financials) are able to gather enough support to force the hand of the management.
My personal opinion is that there is a lot of value in Clearwire stock. Sprint needs Clearwire's spectrum assets because only with that it can compete with Verizon and AT&T.