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Shares of DISH Network (DISH) are falling in Monday's trading session. The pay television company surprised the market by making a merger proposal for Sprint Nextel Corporation (S), in a massive $25.5 billion deal. Shares initially fell some 8% following the announcement of the deal, and are trading with losses of 3% towards the end of the trading session.

A potential deal

Dish made an offer for Sprint Nextel in an attempt to create an industry leading spectrum portfolio, being the only company to offers consumers a fully integrated, nationwide bundle of video, broadband and voice services.

Under terms of the proposal, Dish is willing to offer $7.00 per share for Sprint Nextel, consisting of $4.76 in cash and 0.0593 shares in Dish. Upon completion of a possible deal, shareholders in Sprint would hold 32% of the new combination.

Chairman Charlie Ergen commented on the proposal, "The DISH proposal clearly presents Sprint shareholders with a superior alternative to the pending SoftBank proposal. Sprint shareholders will benefit from a higher price with more cash while also creating the opportunity to participate more meaningfully in a combined DISH/Sprint with a significantly-enhanced strategic position and substantial synergies that are not attainable through the pending SoftBank proposal."

All in all, Dish is willing to pay $25.5 billion for the company while it furthermore assumes some $16.1 billion in net debt held by the company. The equity part of the deal values Sprint at roughly 0.7 times annual revenues of $35.3 billion for 2012.

Dish expects to generate significant revenue synergies and cost savings following the completion of the deal. By offering a fully integrated bundle of services, the company will be able to generate total synergies with a net present value of $37 billion. This includes some $11 billion in cost savings, at an expected annual run rate of $1.8 billion in three years time following completion of the deal.

Another Chapter To Sprint's Take-Over Rumors

While long term shareholders are still suffering from large losses, recent investors in Sprint had more luck. Shares were trading as lows as $2.30 in the spring of 2012 before rumors about a possible deal hit the newswires. Later that year Japanese SoftBank made a proposal to acquire 70% of Sprint's shares of Sprint. In Monday's trading session, shares added another 14% following the proposal from Dish, exchanging hands at little above $7 per share.

While the offer from Dish comes as a surprise, Dish already made an offer for Clearwire (CLWR), which is controlled by Sprint. Backed with a cash infusion from SoftBank, Sprint is looking to buy the remainder of the stake in the company.

Superior Deal

Dish is quick to point out that the terms of the deal are superior to the competing bid from Japanese SoftBank. The cash portion of $4.76 per share represents an 18% premium over the $4.03 cash portion of the SoftBank deal. Shareholders in Sprint will furthermore hold 32% of the shares in the new combination, resulting in a 13% premium compared to the value of SoftBank's offer.

Valuation

Dish ended its fiscal year of 2012 with $7.2 billion in cash and equivalents. The company operates with $11.9 billion in short and long term debt, for a net debt position of roughly $4.7 billion.

The company generated full year revenues of $14.3 billion for the year of 2012, up 1.5% on the year before. Net income fell almost 60% to $637 million after the company took large one-time charges. Excluding one-time charges, net income would have come in around $2.1 billion.

Factoring in a 3% drop in Monday's share price, Dish Network is valued at $16.2 billion. This values the company at 1.1 times annual revenues and 25 times annual earnings. The company is valued at merely 7-8 times adjusted earnings.

Some Historical Perspective

Just like many other US companies, shares of Dish peaked back in 2007 around $50 per share. Shares quickly fell to lows around $10 during the recession, to slowly gain back lost ground in the years following. Shares steadily rose to recent highs around $38 per share, currently exchanging hands at $35-$36 per share.

Between 2009 and 2012, Dish increased its revenues by little over a fifth from $11.7 billion to $14.3 billion. "Normalized" earnings per share more than doubled to $4.63 over the past year.

Investment Thesis

Let's add all pieces together, and it becomes obvious that the smaller but more profitable Dish can actually acquire a much bigger company which reports significant losses.

Combined, the newly formed company will be able to generate annual revenues of approximately $50 billion, of which some 70% is generated by Sprint Nextel. The company is expected to report losses of $2 billion on a normal basis, but will be cash flow positive given the high depreciation charges at Sprint. Factoring in the annual cost synergies run rate of almost $2 billion in three years time, and accounting for the promised revenue synergies, the company could report multi-billion profits.

Following completion of a deal, the combination will have taken up quite some leverage. Dish already works with a net debt position of almost $5 billion while Sprint holds over $16 billion in net debt. Adding to this the $17.3 billion cash price tag of the deal and the net debt position of the pro-forma combination could total some $38 billion.

The shareholder base of Dish will furthermore dilute by approximately 50% following the deal. Some 675 million shares in Dish will be outstanding, valuing the equity of the firm around $24 billion.

Shareholders in Sprint obviously applaud the recent proposed deal as they stand to receive a greater cash component and a stake in a possible more interesting company, given the high estimated synergies following completion of the deal. While Sprint's investors are cheering, shareholders in Dish are still uncertain about the implications if a deal were to go through.

Dish is acquiring a much larger company which loses a lot of money. While Dish reports steady cash flows, management sees the deal as a necessity given the increased competition from large television companies, online content providers and telecommunication providers.

As all technologies and devices are blending together Dish might have possibly made a deal which gives it a first mover advantage. Competition from Netflix (NFLX) and Intel (INTC) for online content requires Dish to take action. Yet the deal comes at a price, being uncertainty and higher debt, but would create tremendous value if the revenue and cost synergy estimates turn out to be only half true.

Source: DISH Network Makes A Transformational Merger Proposal To Acquire Sprint Nextel