Many Clearwire (CLWR) investors were surprised to learn of the board's decision to acquiesce to Sprint's (S) offer to buy the remainder of the company for $2.97 per share. Sprint seemed to have a lock on Clearwire, with the company barred from shopping itself to other bidders, and Sprint was further protected by a maze of contractual clauses. While Crest Financial, Clearwire's largest non-strategic investor, has sued to block the deal, many thought that Sprint's bid marked the end of the road for Clearwire and its investors. But, on January 8, DISH (DISH) entered the fray, offering $3.30 to acquire all outstanding shares of Clearwire. Many analysts and commentators believe that DISH has little to no chance of actually acquiring Clearwire, and we share their belief that this is unlikely to be DISH's real goal. DISH CEO Charlie Ergen is one of the shrewdest businessmen in America, and he is certainly aware of the difficulty of gaining control of Clearwire. However, neither Charlie Ergen nor Clearwire's investors need DISH to take control for them to win. An analysis of DISH's offer, and the contractual framework of Sprint's own offer shows that DISH and Charlie Ergen have backed Sprint into a corner, a corner that will result in a higher offer for Clearwire investors.
The DISH Offer: A Gambit from Charlie Ergen
Under the terms of Sprint's own offer for Clearwire, the company is barred from shopping itself to other buyers. However, the special committee of Clearwire's board of directors that has been set up to negotiate a deal for Clearwire has a fiduciary duty to maximize value for non-Sprint investors in Clearwire, and therefore must consider DISH's offer, a fact surely known by DISH and Charlie Ergen. Before DISH's offer to "simply" buy all of Clearwire for $3.30 per share, DISH made another, scaled down offer for Clearwire's spectrum, containing the following provisions:
- Buying spectrum: DISH plans to acquire up to 24% (11.4 billion MHz-POPs) of Clearwire's spectrum, for a total of $2.2 billion in cash, which equates to a valuation of $0.19298/MHz-POP. While this offer does leave Clearwire with almost 75% of its existing spectrum, the valuation it assigns to that spectrum is below many recent transactions, including DISH's own purchase of TerreStar spectrum.
- Network Partnership: DISH and Clearwire would then sign a deal under which Clearwire would provide "commercial" services to DISH, including the construction, operation, and maintenance of a new wireless network incorporating Clearwire's spectrum, as well as DISH's existing spectrum.
- Governance Rights and Full Takeover: In its preliminary bid, DISH already disclosed its interest in acquiring all of Clearwire, subject to several conditions. DISH is to acquire no less than 25% of Clearwire, and it must receive protections designed for minority investors. In addition, DISH is to receive governance rights proportionate to its stake in Clearwire.
- Sprint financing: DISH has stated that this offer would be withdrawn if Clearwire draws down on the financing offered by Sprint as part of its own deal for Clearwire.
Clearwire, as bound by its fiduciary duty to minority shareholders, has begun to examine DISH's proposal, and has not begun to draw down on Sprint's loan as it sorts out these offers. Naturally, Sprint fired back, arguing that DISH's proposal is "illusory, inferior to the Sprint transaction and not viable because it cannot be implemented in light of Clearwire's current legal and contractual obligations." In essence, Sprint argues that there is no way for DISH to actually gain control of Clearwire due to the variety of governance restrictions Sprint has placed on Clearwire. And Sprint is unlikely to vote its 50%+ stake in Clearwire in favor of DISH's proposal in any case. Surely Charlie Ergen is aware of this fact. But if that is the case, why make this bid at all? The answer, as always, is that Charlie Ergen is doing what is best for his company's investors, including himself. But in this case, what is best for Charlie Ergen is also what is best for Clearwire's investors.
Sparking a Bidding War
Even if Charlie Ergen were to back down, the dynamics of this three-way corporate chess game favor Clearwire shareholders. We explain below, and base our explanation on the following assumptions:
- DISH is prepared to acquire all outstanding shares of Clearwire, which would cost the company around $5.5 billion, but does not expect that the situation will go that far.
- As many analysts believe, DISH's proposal is meant to drive Sprint towards a deal with it in exchange for dropping the offer to acquire Clearwire for $3.30 per share.
- Clearwire is serious when it suggests that failure to close a deal could lead to a financial restructuring, which is code for bankruptcy (we will address this issue later in the article).
- Sprint needs to take control of Clearwire to solidify its own competitive strategy relative to AT&T (T) and Verizon (VZ).
According to Reuters, sources close to Sprint's executive team believe that the company has the power to block DISH's bid (for the record, sources close to Clearwire also say that company's executive team believes that a deal with DISH can be completed, even if it would be highly complex, and could result in DISH and Sprint splitting control of the company). However, in the end, we believe that Sprint will up its offer for Clearwire from $2.97 per share, because of a fatal flaw in the way that its agreement to acquire Clearwire is structured. One of the core points of Sprint's argument that DISH can never acquire control of Clearwire is that a sale of Clearwire requires approval of 75% of Clearwire's investors. However, that requirement extends to Sprint's own proposal to take control of Clearwire. Under the terms of its deal, Sprint must secure the approval of over 50% of Clearwire's minority investors. An analysis done by the Wall Street Journal shows that Sprint's hand is not as strong as the company believes.
Clearwire Ownership, Wall Street Journal Analysis
Investors Supporting Sprint
Strategic investors such as Comcast (CMCSA) and Intel (INTC) have committed themselves to supporting Sprint, and are now required to vote their shares alongside Sprint. However, between these 2 groups (Sprint and Clearwire's strategic investors), Sprint has just 13% of Clearwire's minority shares. Crest Financial, which owns 8.3% of Clearwire, has already expressed its opposition to the Sprint deal. And Mount Kellet, which owns 7.3% of Clearwire, is also likely to oppose the sale to Sprint, given its communications with both Crest Financial and Clearwire's board of directors. Between them, these 2 firms own 15.6% of Clearwire, meaning that only 9.4% of Clearwire's total shares are needed to block Sprint from taking control of Clearwire. And it is likely that many of the investors who make up the Wall Street Journal's 29% undeclared investors are retail investors who are holding out for a higher offer. And it is possible that DISH itself has been buying Clearwire's stock. In this case, every share counts, and DISH is likely providing itself with a bargaining chip in the form of Clearwire stock.
Sprint's core problem is that while it has the power to block a sale of Clearwire to Sprint, it faces a material risk of having its own bid for Clearwire blocked by the company's minority investors. We fully agree with Crest Financial that Sprint's bid undervalues Clearwire, and will be voting against Sprint's offer, if and when it comes to a vote, and urge all Clearwire investors to do the same. Although Crest Financial lost its motion to fast track its lawsuit against Sprint and Clearwire's board this week, Delaware Chancellor Leo Strine Jr. allowed the case to proceed, albeit at a normal pace, and suggested that Crest Financial could re-file its motion for a fast-track suit. All of this leaves Clearwire in limbo, something we believe is worse for Sprint than Clearwire. As Macquarie analyst Kevin Smithen stated, "We don't think Sprint can afford to chance any delays to a Clearwire closing, and we believe a compromise 'kiss' bid at $3.50-$3.75 (per share) would be sufficient to get dissident Clearwire minority holders and Dish to back down." The enormous volume that Clearwire's shares have seen in the past few months has made it unclear exactly who the Clearwire shares currently not "pledged" to either side (in support or opposition of Sprint), although we believe that the majority of these shares will be in opposition of Sprint. And therein lies the upside for Clearwire's investors. While Sprint may be able to block DISH's bid, it cannot close its own deal for Clearwire without the support of more minority shareholders, something that the company is unlikely to get without increasing its bid, possibly to $3.50-$3.75 per share, just as Macquarie analyst Kevin Smithen believes it will do.
Bankruptcy: Is it Really That Bad?
Clearwire itself has argued that should the Sprint offer fail to close, it may be forced into a financial restructuring, which is code for bankruptcy. Let us assume then, for a moment, that Clearwire will indeed file for bankruptcy. In bankruptcy, a company tries to pay off its creditors first, with the remaining proceeds, if there are any, going to its shareholders. Per Clearwire's latest 10-Q filing, the company has assets of $8.149,658,000, and liabilities of $5,861,936,000. That leaves Clearwire with $2,228,722,000 in equity. When divided across the company's 1,464,966,472 shares, that equates to a value of $1.56 per share, essentially setting a "floor" for the company's value in bankruptcy. And that assumes that Clearwire's spectrum is not auctioned off, but simply sold at its book value (which currently stands at around 9 cents/MHz-POP). If the spectrum were to be auctioned off (the likely result of a bankruptcy filing), it is likely that the company's investors will see a larger payout; for Clearwire's creditors are only entitled to the money they lent the company. Everything above that goes to Clearwire's shareholders. We have addressed the issue of a Clearwire bankruptcy filing in two previous articles [here, and here, with the issues of liquidation rights and Clearwire Communications (where Clearwire's spectrum is housed) addressed] and continue to believe that the risks of a filing are overblown. Furthermore, a bankruptcy filing by Clearwire would throw Sprint and SoftBank's plans into chaos; Sprint's bid for Clearwire shows that it is essential to both its network expansion plans and its ability to compete with AT&T and Verizon on an entirely new level. A bankruptcy filing could threaten Sprint's hold on Clearwire's spectrum, and Sprint has shown time and again that it will not let Clearwire file for bankruptcy, for the threat of that spectrum falling into unfriendly hands is too great.
It is true that under the terms of DISH's offer, Clearwire is barred from borrowing from Sprint (due in large part to the equity component Sprint's financing offer contains). And under the terms of its agreement with Sprint, it is barred from borrowing from DISH. However, Clearwire is in no immediate cash crunch. The company ended Q3 2012 with $1.183668 billion in cash & investments, and the company's operating cash burn for the first 3 quarters of 2012 was $181.744 million. Even if operating cash burn were to jump to $300 million per quarter, Clearwire would still have more than 3 quarters of cash on hand (the company's debt begins to mature in 2015). Clearwire has time to extract the highest possible offer for its investors.
DISH's entry into the Clearwire story is a positive development for Clearwire investors. While Charlie Ergen is interested only in helping DISH investors, his actions, in this case, also serve to help Clearwire's investors as well. We believe that Sprint will be forced to raise its bid for Clearwire, given that there is likely to be enough opposition to its $2.97 per share offer to block the deal. Existing investors in Clearwire should hold onto their shares, which is what we have done, for we believe that a higher offer will arrive in due time. The nuances of DISH's bid, the contractual framework of Sprint's own bid, and the importance of Clearwire all suggest that Sprint will need to raise its bid if it wishes to take full control of Clearwire.