Sprint Walks Away From MetroPCS

Includes: S, TMUS
by: Karl Denninger

The pundits will say this was bad. I think it's good.

Sprint Nextel Corp. (NYSE:S) abandoned plans to buy MetroPCS Communications Inc. (PCS), two people with knowledge of the matter said, walking away from a deal that might have helped the mobile-phone carrier vie with Verizon Wireless and AT&T Inc. (NYSE:T)

The transaction would have valued MetroPCS at about $8 billion, said one of the people, who asked not to be identified because the discussions were private. It was rejected by Sprint’s board, this person said. The transaction included a 30 percent premium, CNBC reported yesterday.

Too much.

MetroPCS is a decent business, but it's centered around a handful of markets -- markets where Sprint already has presence and spectrum. MetroPCS is spectrum-poor but customer-rich, which means Sprint was buying a customer base, not spectrum growth.

They were the first in the nation to actually get deployable LTE out there to the people, more out of necessity than anything else. LTE is more spectrum-efficient, so the direction was obvious.

But this doesn't change the reality that Sprint has spectrum all over the place now, albeit disjointed spectrum. Adding MetroPCS wouldn't have materially changed Sprint's profile in that regard. And MetroPCS is primarily a carrier that sells to "underserved" urban markets -- read, people without a lot of money who want a smartphone.

It's a decent business but it's not one that, in my view, justifies a significant premium over market valuations. PCS was trading at the close of business at 14 times earnings and about 1x sales, but 1.4 times book -- for a company with an operating margin of 15% and a ROA of 5.4%.

It's also got a lot of debt on the books, about 1x revenue. With a 15% operating margin that's approaching seven years of operating profits in debt, which IMHO is just too damn much.

You can look at Sprint and find some ugly numbers too -- but their debt is ~60% of revenue as opposed to 100%. While PCS is making money where Sprint is currently not on a revenue basis PCS is more-highly levered than Sprint is!

If Sprint would have been buying big spectrum I would have said this deal might have made sense. But they weren't, and as such it didn't.

IMHO the board was right to walk off -- it simply was too expensive, and frankly, I would have had trouble on an analytical basis justifying it even if there was no premium over the stock's market price.

Disclosure: The author has a speculative position in Sprint (S), but none in PCS.