Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Shareholders in Leap Wireless (LEAP) received an unexpected positive surprise at the end of last trading week. On Friday after the market close, the company agreed to sell itself to AT&T (NYSE:T).

Shares more than doubled towards $17 per share in a response to the offer, reaching their highest level since the summer of 2011. As Leap has no right of existence on a stand-alone basis, investors receive a very fat premium for their troubled holdings.

The Deal

Leap Wireless announced that it has reached an agreement with AT&T under which the company will sell itself for $15 per share in an all-cash transaction.

With the acquisition, AT&T will get a hold of the wireless properties of Leap, which includes licenses, network assets, retail stores and some 5 million subscribers. The deal excludes the proceeds from the sale of Leap's 700 Mhz spectrum in Chicago. Leap bought these assets for $204 million back in August of 2012.

The deal values Leap's equity at around $1.18 billion and represents an astonishing 88% premium over Friday's closing price. AT&T will furthermore assume $2.8 billion in net debt, marking a total enterprise value of around $4.0 billion.

AT&T will retain Leap's Cricket brand name, giving its customers access to AT&T 4G LTE mobile networks. The deal will result in improved customer service and a better mobile Internet experience.

The deal is complementary to AT&T's strategy of buying spectrum licenses. The company will furthermore add mobile users to its 4G LTE network, to enhance customer's experience with mobile Internet usage.

A group of investors, which hold a total of 29.8% of Leap's outstanding shares, have already agreed to tender their shares. The deal is furthermore subject to a review of the Federal Communications Commission and is expected to close within six to nine months.

Valuation

AT&T ended its first quarter of 2013 with $3.88 billion in cash and equivalents. The company carries along a massive $74.13 billion total debt position, resulting in a net debt position of just above the $70 billion mark.

For the year of 2012, AT&T generated revenues of $127.4 billion, up a mere 0.6% on the year before. Net income rose by a spectacular 84% towards $7.3 billion.

Trading around $36 per share, the market values the company at $194 billion. This values the firm's equity at 1.5 times annual revenues and 26-27 times annual earnings.

AT&T pays out a fat quarterly dividend of $0.45 per share, for an annual dividend yield of 5.0%.

Some Historical Perspective

Long-term investors in AT&T have seen decent returns on their investment as moderate capital gains were accompanied by really high dividends. This has provided investors with superior returns if they have reinvested their dividend proceeds.

Shares rose from $25 back in 2003 to highs around $40 back in 2007. As a result of the financial crisis, shares have fallen toward $25 in 2009 only to recover to recent highs of $39. At the moment, shares are exchanging hands around $36 per share.

Between 2009 and 2012, AT&T has managed to grow its annual revenues by merely 4% on a cumulative basis. Net income fell by 40% in the meantime towards $7.3 billion.

Investment Thesis

The rationale behind the deal is to expand AT&T's 4G LTE network. The 5 million pay-as-you-go customers are a little bonus to the deal. The total $4 billion price tag, including the assumption of debt, is quite a bit in absolute terms. On a relative basis, the $4 billion enterprise value represents just 1.5% of AT&T's own enterprise valuation, and 1.5% of its annual revenues.

CEO Randall Stephenson has been buying a lot of spectrum after the $39 billion deal with T-Mobile USA, which was proposed in 2011, was blocked. Earlier this year, AT&T already spent $1.9 billion to acquire spectrum from Verizon Wireless. The increased data usage of customers on mobile devices has created a need to consolidate. As a result, U.S. carriers are rapidly consolidating to accommodate the increased capacity to handle the increase in data usage.

Following the deal, shares of Leap more than doubled towards $17 per share. This seems rather fair as AT&T offered $15 per share in cash, and investors stand to receive possibly another $2.50 per share in cash from the sale of spectrum in Chicago, bought last year.

It is important for AT&T to fortify its leading positions next to Verizon Communications (NYSE:VZ). Other smaller companies have already consolidated their operations. T-Mobile ended up merging with MetroPCS while Japanese SoftBank completed the purchase of Sprint Nextel (NYSE:S).

While long-term shareholders in Leap have seen terrible returns, after reaching highs of almost $100 in 2007, they are best advised to tender at current levels. Of course, those investors who bought back in June of this year, and have seen shares nearly triple, are probably eager to tender.

The tough competition in the pre-paid market, accompanied with disappointing margins, has resulted in large losses for Leap in recent years. As such the company has no right of existence as a stand-alone business.

The deal is a winner for both companies. AT&T buys more spectrum, and adds 5 million pay-as-you-go customers. Leap's shareholders receive an extremely nice premium for their decimated holdings.

As such, investors are best advised to tender.

Source: AT&T - A Small Acquisition, A Giant Leap For Shareholders