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James Emerson, CFA
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Hedge fund trader and analyst specializing in REIT, hotel, home building, real estate, financial, and consumer discretionary stocks. Preferred stock expert. Extensive experience investing using a variety of typical hedge fund strategies including long/short equity, merger arbitrage, capital... More
  • Look before you LEAP  1 comment
    Mar 21, 2011 6:23 PM | about stocks: T, VZ, TMUS, S, USM, TDS
    In response to the news that AT&T and T-Mobile have agreed to merge, Leap Wireless International (LEAP) posted an almost 16% gain today closing at $14.05.  From a techinical standpoint there appears to be resistance around $14.25 and the stock is in overbought territory.  Look for a rapid reversal as the prospects for a takeover or improving operating margins prove illusory.  The price action provides an excellent entry point for a short term short.    

    After eliminating T-Mobile and AT&T,  the universe of potential merger partners is Verizon (NYSE:VZ), Sprint Nextel (NYSE:S) Metro PCS (PCS) and U.S. Cellular (NYSE:USM).  There is no strategic or financial rationale for any of these companies to acquire Leap. 

    Verizon has assets of over $220 billion and a market cap of over $100 Billion.  So from a financial perspective, the acquisition of Leap's $4.8 billion of assets or $2.7 billion of revenue would not be meaningful.  From a strategy perspective, Verizon offers service in all Leap's markets and Leap's 5.5 million subscribers only generate ARPU of about $38, below the level of Verizon subscribers.  Verizon's strategy is to move customers to smart phones and drive revenue, not to acquire voice and text customers. 

    Sprint-Nextel has its own issues and is struggling to compete with the top three providers for post pay customers.  Further Sprint has had a bad experience with mergers.  While an acquisition of Leap does not pose the same issues as the Nextel integration, there is little strategic or financial rationale to acquire 5.5 million low margin customers and the $2.8 billion of debt that comes with them.   Further, Boost offers essential the same service as Leap's Cricket with a better value proposition.  Boost pricing is slightly higher but with on time payments declines to be in line with Cricket.  Additionally, Boost has arguably better phones, no roaming charges and better coverage.  Therefore, unless Sprint acquires Leap the pressure on margins will continue unabated.   

    US Cellular operates with a business model more similar to AT&T, Verizon and Sprint.  Adding Leap would only reduce all its operating metrics and saddle the company with debt.  Additionally in the unlikely event that USM pursued a takeover, the company would probably have to execute a stock for stock transaction that would probably not include a premium to Leap shareholders. 

    For a geographic perspective and a business model stand point, Metro PCS makes sense as an acquirer.  The geographic fit is good and the business model is the same; however, the financial fit is bad.  Leap's margin are essentially zero after backing out impairment.  I wouldn't project significant marketing or operating synergies from a merger so all PCS would accomplish by merging is to diminish value for its shareholders.  Again given Leap weak operating metrics, PCS is unlikely to offer a premium.  

    The stock is weak on fundamentals and the technicals point to a top.  Look for a reversal after the euphoria wears off. 

    disclosure:  no positions, just opinions 



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Stocks: T, VZ, TMUS, S, USM, TDS
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  • Roger Newman
    , contributor
    Comments (251) | Send Message
     
    I agree!
    22 Mar 2011, 01:36 PM Reply Like
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