Sprint Nextel Corp. (S)'s shares got a 7% boost on Wednesday after the chief executive officer of the third largest U.S. wireless company showed his interest in a future consolidation. The company's shares have already more than doubled since the start of the year, closing at $5.56 after surpassing its previous 52-week high of $5.5.
The chief executive, speaking at a Goldman Sachs conference yesterday, said that consolidation between smaller telecom operators in the U.S. would bring healthier competition and increase their market share, as opposed to the two telecom operators that currently have the biggest market share in terms of customer subscribers. Currently, Verizon (VZ) and AT&T (T) hold almost 80% of the postpaid market, with a combined customer base of almost 159 million, towering over the 54 million for T-mobile and Sprint. However, the positive to come out of the failed acquisition of T-Mobile USA by AT&T was that it prevented further concentration of power, and prevented an already large company from gaining an even bigger market share. But one would imagine that a possible deal between Sprint and T-Mobile, or even MetroPCS Communications (PCS), will not result in the aforementioned concentration in the market share, and it doesn't seem likely that the FCC or the Department of Justice will object in case the smaller telecom operators decide to consolidate their operations.
In a previous report, we mentioned the advantages of consolidation between Sprint and MetroPCS Communications, as opposed to a Sprint and T-Mobile deal, and explained what both companies would stand to gain in case that happens. The prime reason is that PCS will exert a significantly less debt burden on Sprint if it decides to take over. Moreover it would give the company access to the prepaid market that PCS is serving. However, we believe that Sprint is unlikely to involve itself in any consolidation for now, despite its CEO saying so and the company's persistent interest in taking over companies like T-Mobile and PCS, mainly because of its network vision program. The company is currently going through its $5 billion network upgrade plan, which the company is expecting will bring in financial benefits of over $10 billion going forward. Apart from the financial benefits, it will achieve various operational benefits as well, like energy efficiency, better network coverage, and call quality. Until it completes the project, which is expected to be concluded next year, we believe the company will stay away from any take over.
Sprint is in the process of shutting down its Nextel network, which has been consistently shedding customers for quite some time now; however, it has done well to retain the customers on its Sprint network. The recent migration from its Nextel network came from the federal emergency management agency (FEMA), which will purchase 2,000 Sprint direct connect handsets for its mass evacuation program. Moreover, in a recent press release, the company announced that its push to talk service has crossed the one million customer milestone, as more customers migrate towards services on its network. As part of the network vision program, Sprint direct connect network will have triple the square miles of coverage as compared to its Nextel network. The company has started to roll out its 4G LTE network only recently, and has much less coverage than Verizon and AT&T. Selling over 1 million LTE enabled smartphones in less than six months is certainly impressive but not too surprising because it has been adding LTE enabled smartphones to its portfolio, which include heavyweights like the Samsung Galaxy S3 and HTC EVO. It is also one of the three telecom operators in the U.S. that are currently offering the new iPhone 5.
We believe the company has done exceptionally well in terms of staying on track with its network vision program, which will lead to margin expansion in the coming quarters. It has also simultaneously expanded its smartphone portfolio. Moreover, a possible consolidation between smaller telecom operators will certainly be of value to Sprint, as it will open the door for more spectrum and air waves for the next generation LTE technology. S looks undervalued based on almost all valuations. P/S of 0.4x is much lower than Verizon's and AT&T's P/S of 1.14x and 1.7x. The stock trades at an EV/EBITDA of 6x, as compared to 8x for AT&T and 5x for Verizon. The stock is up almost 65% since our last report, and we believe that a further upside exists. Recent upgrades have come from Nomura, upgrading the shares from neutral to buy, whereas RBC Capital and Piper Jaffray have reiterated their sector perform and overweight ratings for the stock. Currently, 45% of sell side analysts have a hold rating on the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.