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On October 2, 2012, Sprint's stock (NYSE:S) plunged more than 5% on the news that Deutsche Telekom (OTCPK:DTEGF), the parent company of T-Mobile, is looking to buy MetroPCS (PCS). Obviously, shares of MetroPCS climbed sharply - nearly 18%.

Sprint: 9/27/2012 to 10/2/2012
(Click to enlarge)

Another interesting development this week was the downgrade of Sprint's stock to Market Perform from Outperform by Raymond James' Analyst Ric Prentiss, with the justification that Sprint's recent stock price appreciation was largely due to M&A anticipation.

Sprint's extreme 12% pullback since September 27, 2012 may not be over, as more news about the M&A activity come out. However, at this price, Sprint's stock is worth taking a look. I believe the circumstances have suddenly created a buying opportunities for investors who felt left out.

Another Sprint-Nextel In The Making?

In 2005, Sprint had merged with Nextel and the decision was cheered by Wall Street and shareholders alike. However, there was a fundamental reason why this merger was bound to fail. Mergers between telecommunication companies are heavily dependent on infrastructural and technological compatibilities, and both were missing in the Sprint-Nextel deal.

In this aspect, the T-Mobile and MetroPCS deal is similar.

  • Both companies have incompatible network standards - MetroPCS uses CDMA while T-Mobile largely depends on GSM and HSPA technologies.
  • Both companies have different business models. MetroPCS is completely in the Prepaid market, while T-Mobile's business is mostly Postpaid with a little bit of Prepaid. But T-Mobile's Prepaid business has seen lower margins and their Postpaid business has seen a loss of 250,000 customers in Q2 2012 alone. How a merger could suddenly change the ARPU and subscriber base metrics for the combined company in the short run is unclear, especially because by the time the merger is done, Sprint would have run away with a lot more subscribers thanks to its better product line and generous plans.
  • iPhone 5 remains an important factor. Neither T-Mobile nor MetroPCS have this best selling phone, which has been a blessing for carriers in regard to subscriber gains and loyalty, even though it comes with a huge cost because of the subsidy. There were issues related to the spectrum band used by MetroPCS and the Apple phones, which was probably MetroPCS could not push for iPhones more aggressively. This will change in the future, but the important thing is that the competitor would have gained many more subscribers until that happens.
  • LTE is another important factor. T-Mobile is not quite there yet with LTE technology (plans are to start next year), and MetroPCS has recently begin LTE deployment. Nevertheless, both companies are way behind Sprint, which has already sold 1 million LTE devices so far in 2012 and plans to deploy LTE in 100 cities by next year.

Sprint's Turnaround Story

Frankly, not a lot has changed in Sprint's impressive turnaround story since September 19, 2012, which was when I had covered Sprint and recommended as a buy with $6.50 price target. Investors must keep in mind that the following aspects of the company's recent progress is unrelated to any M&A activity in the telecommunications space, and is purely organic improvement on the company's part.

  • Sprint has improved its brand recognition in the past year, especially after getting the iPhone 4s, iPhone 5 and the Samsung (OTC:SSNLF) Galaxy S series phones. Their differentiating factor is a popular product line with a generous data plan and an expanding LTE network. The company's iPhone sales were better than expected according to their recent earnings call, and they did not result in a fiscal hole for Sprint like many analysts expected.
  • Sprint is expected to lose $1.40 per share in 2012, but in 2013 and 2014, the losses will decrease substantially. In fact, the company should start making more money per share in 2014.
  • Sprint's Network Vision modernization plan remains on track and will reduce the company's cap ex significantly in the long run.
  • LTE demand is expected to increase and Sprint has already entered into the LTE capable tablets market. According to this recent report, the demand for new LTE smartphones and new LTE capable tables is up 33% and 72% respectively in 2012 so far.

Industry Consolidation Likely To Continue

On September 27, 2012, MetroPCS had announced that apart from Deutsche Telekom, the company has talked with DISH Network (NASDAQ:DISH) and Sprint for merger, and also stated that "some talks are ongoing, other talks are off and on." It was probably this news that sent Sprint's stock tumbling down since this date.

Verizon (NYSE:VZ) and AT&T (NYSE:T) are both pushing for clearer regulatory guidelines from the Federal Communications Commission (FCC) regarding spectrum ownership, to prevent mishappenings like the AT&T and T-Mobile's failed merger. This only means that both companies are keen on more acquisitions in the next couple of years, and the spectrum was is not over yet.

Conclusion

No doubt, a merger between MetroPCS and T-Mobile creates a bigger competitor for Sprint. The important thing though, is how this new competitor will manage the integration of incompatible technologies and whether it will incur increased subscriber losses while trying to handle two different sets of customer bases and brands, and especially in trying to switch existing subscribers to some newly created network.

My opinion is that Sprint will in fact benefit if the merged company's execution fails like it did for Sprint-Nextel, and irrespective of this M&A deal, that Sprint will continue to benefit from its own turnaround efforts and be profitable in the next two to three years.

Also, I believe that Sprint's organic ARPU growth and increased subscriber base are the dominant factors in the stock's price appreciation, and that any disappointment arising from M&A activity may have been already priced in during this 12% drop in the past few days. The stock could continue to be volatile as more news around this deal come out, but any extreme pullbacks from this price point appeal to me as buying opportunities.

Risks

If Sprint decides to chase the deal to outbid Deutsche Telekom, how much additional premium will Sprint be willing to pay, and more importantly afford? One must remember that the company is on a tight budget especially during the Network Vision project, and that the company is still leaking money on a per share basis.

Price Opinion for Sprint: Buy

Source: Sprint's Pullback Is A Buying Opportunity