In a letter to the Federal Communications Commission (FCC), the U.S. Department of Justice (DOJ) has asked the commission to hold off its review for the Sprint (S)-Softbank merger. The merger is being investigated by the DOJ, the Federal Bureau of Investigation (FBI) and the Department of Homeland Security (DHS), for any potential impact on national security, public safety or law enforcement. As the matter is still under investigation, the commission has been asked not to review the merger until the investigation is complete.
In October 2012, Sprint had announced a 70% stake sale of the company, to Japanese telco Softbank. The complex $20 billion agreement allows Softbank to purchase 55% of Sprint at $7.30 per share, and infuse a total of $8 billion in cash at $5.25 per share in two separate transactions. Sprint has already received $3.1 billion in convertible debt as part of the deal and the rest of the cash transaction is to be done after the regulatory approval. The capital infusion was supposed to help Sprint close the Clearwire acquisition and put the rest towards improving its network, but the recent developments seem to have roadblocked the company’s growth plans.
In another corporate drama earlier this month, Clearwire (CLWR) announced that it received an unsolicited bid from DISH Network (DISH) that outbids Sprint’s offer by $500 million, coupled with an offer to buy 24% of Clearwire’s spectrum for $2.2 billion. DISH has also proposed a commercial agreement and capital assistance for Clearwire’s network build-out. DISH is offering $3.30 per share, compared to $2.97 offered by Sprint for Clearwire. This new development has upset the plans for the newly invigorated Sprint that has been significantly counting on acquiring Clearwire, to strengthen its bandwidth. With the delay in the Sprint-Softbank merger process and growing dissatisfaction among the minority holders of Clearwire with Sprint’s offer, we feel the entire situation could play out in one of the following ways.
Scenario 1: Sprint Matches DISH’s Offer Leading To Bidding War
Sprint would be forced to revise its offer for Clearwire to match DISH. Despite Sprint owning 50% of Clearwire, the latter’s management and board have a fiduciary duty towards its investors and would have a hard time justifying a sale at a lower price. We feel that DISH has the balance sheet to mount a lengthy and painful bidding war for Clearwire. This will force Sprint to potentially overpay as it desperately needs the additional spectrum to successfully compete with Verizon (VZ) and AT&T (T). Any additional diversion of capital to this acquisition will slow down Sprint’s aggressive growth plans and hurt its gross profit margins, which are dependent on improving operational inefficiencies.
Scenario 2: Board Rejects DISH And Approves Sale To Sprint
This would drag Sprint and Clearwire into a prolonged class action lawsuit by investors. The top five institutional holders own nearly 28% of outstanding shares and would be forced to rethink their approval of the Sprint deal in light of recent developments. A lawsuit could be a headwind for Sprint that is desperately fighting to stay relevant in the wireless market. An Federal Trade Commission (FTC) intervention cannot be ruled out as Sprint would effectively be barring a potential entrant to the highly concentrated wireless market. The FTC could very well order an open auction of Clearwire’s spectrum since Sprint’s 50% stake in Clearwire could be construed as anti-competitive business practice.
Scenario 3: DISH Acquires Clearwire
This would leave DISH in control of significant spectrum, thanks to its recent FCC approval to use its existing spectrum for wireless service. Although rolling out a nationwide wireless service is capital intensive, this scenario will provide DISH with an upper hand when negotiating a potential partnership with Sprint, or other carriers. We believe Sprint will be the most likely contender for a partnership with DISH. The terms of such a deal may be heavily favorable to DISH as it holds the upper hand. It would be hard to predict how Softbank will respond in this scenario since there was intense speculation in the media that the Sprint acquisition is an indirect play for Clearwire’s spectrum. Softbank’s announcement of the Sprint merger wasn’t received well by Softbank investors, and with the loss of Clearwire, investors will seriously question the rationale behind such an expensive acquisition.
This year, Sprint plans to spend $4 billion on capital expenditure. These capital expenditures are much more than what Sprint has historically spent. Moreover, Sprint is highly sensitive to CapEx increases as can be seen by moving the trend line in the forecast chart below and following the corresponding impact on its price estimate. The additional spectrum capacity will go a long way in bringing these costs down. Hence, the loss of Clearwire will adversely impact one of the key goals of Sprint’s Network Vision plan to improve margins as it would have to increase its capital expenditure to make up for the loss of Clearwire.
Irrespective of how this new development plays out, Sprint investors are bound to be jittery again after a couple of months of renewed confidence in the company, post the Softbank deal.
Disclosure: No positions