Why Verizon Must Buy Sprint

Includes: S, VZ
by: Tim Ayles

With yesterday's major telecom merger announcement between AT&T (NYSE:T) and Deutsche Telekom AG T-Mobile unit (OTCQX:DTEGY), the pressure will be on for Verizon (NYSE:VZ) to do something to keep up. Yesterday's merger leaves the US with only three large carriers, and Sprint Nextel (NYSE:S) is now a distant third in market share. Verizon may want to consider how yesterday's merger leaves each Sprint Nextel subscriber valued about 77% lower than each T-Mobile subscriber.

Sprint's stock was hammered yesterday on the news that they will not be the company merging with the 34 million T-Mobile customers (which would have ranked them near the top in market share). When I look at the numbers though, Sprint, while having a lot of debt and other problems, is loaded with value, and is a company that Verizon should look at acquiring, regardless of potential network integration problems.

At yesterday's $39 billion purchase price of T-Mobile, AT&T is spending about $1150 per subscriber to acquire the 34 million wireless customers. When comparing that to the 50 million customers that Sprint Nextel has, Verizon could acquire the entire company today for under $13 billion (current market cap), or only $260 per subscriber. Granted, Sprint Nextel has a ton of debt from its miserable acquisition of Nextel back in 2004, but the debt is being paid off by the massive amount of free cash flow the business is currently generating. Sprint should generate nearly 80 cents per share of free cash flow this year, which is about a 20% free cash flow return based on current share prices.

Even with $18.5 billion in long term debt, the company could use the entire FCF amount to knock out that debt in as little as 6.5-7 years. With that large debt load, the company currently has a book value per share that is higher than the share price. Knocking out the debt aggressively over the next few years will only increase the book value going forward.

The bottom line when viewing Sprint Nextel, though, is realizing that the company has stopped the subscriber attrition rates it was experiencing from terrible customer service results after the Nextel merger. Since then, their customer service scores have at times ranked higher than the big firms. By raising customer satisfaction, along with gaining enough clients in the prepaid and regular Sprint service to offset the losses in the Nextel brand, Sprint should continue to gush cash for its shareholders.

I find it hard to think that each Sprint customer is worth 77% less than each T-Mobile subscriber that AT&T just bought. If a buyer finds a Sprint customer to be worth only HALF of what a T-Mobile subscriber is worth, Sprint shares would double from here. Verizon, if you are listening...... at 77% less per subscriber, you could become the top wireless company by subscriber, and do it at a very cheap cost per subscriber. What are you waiting for?

Disclosure: I am long OTCQX:DTEGY, VZ, T. I am considering buying S within the next 72 hours, but do not currently hold a position.