- A Sprint - T-Mobile merger could overcome regulatory hurdles in our view.
- Assuming cost synergies equal to 15% of T-Mobile cash operating costs, Sprint would save more than $3bn EBITDA a year.
- Applying Sprint’s 2016 EV/EBITDA of 7x to the new group, we get to a valuation close to $14/share.
- The risk/reward is highly attractive: in a worst case, the downside would be limited while in a best case, the upside would stand around 50%.
Speculation keeps rising about a potential Sprint (NYSE:S) - T-Mobile (NYSE:TMUS) merger. While many analysts and investors doubt that the alleged deal will get regulatory approval, we believe that this is the right time to invest in Sprint as the risk/reward appears highly attractive.
Scenario #1 (the deal fails): limited downside
If observers are right, we see limited downside for the Sprint stock as the merger and subsequent synergies are clearly not factored into the current stock price. Sprint is down 13% year-to-date while merger rumors have been there for a while.
If the deal fails, Sprint would get back to square one. Admittedly, Sprint's operating metrics and competitive position are far from being healthy, but the group's difficulties are well flagged and factored in the stock price.
Scenario #2 (the deal goes through): huge upside
Our main scenario is that the merger could overcome regulatory hurdles in view of two main factors.
First, competition would not be drastically reduced in the U.S. wireless market. The AT&T - T-Mobile merger was blocked 3 years ago because AT&T would have reached a dominant position in the U.S. but this time around, it's about merging players #3 and #4. The combined entity would have 53m postpaid subscribers vs. 97m at Verizon and 73m at AT&T and would remain #3 player.
Second, there has been a wave of consolidation in the telecoms/cable/media space recently that could lead regulators to be more open to such a transaction.
If the deal goes through as we expect, the impact on earnings and valuation could be huge. Assuming cost synergies (network, advertising…) equal to 15% of T-Mobile cash operating costs, Sprint would save more than $3bn EBITDA a year.
The combined entity would deliver EBITDA around $19bn in 2016 (consensus figures). Applying Sprint's 2016 EV/EBITDA of 7x to this figure, we get to a $133bn EV for the new group. Taking into account Sprint's net debt ($28bn by 2016) and a likely equity offering to finance the T-Mobile acquisition ($32bn or 3.5bn new shares), we get to a valuation for the new Sprint close to $14/share.
In all, the risk/reward is highly attractive: in a worst case, the downside would be limited while in a best case, the upside could stand around 50%.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.