Sprint’s Fundamentals Would Benefit From A SoftBank Investment

October 12th, 2012 by Trefis Team
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In a surprise move that saw Sprint’s (NYSE:S) shares jump nearly 15% in trading Thursday, the carrier confirmed rumors that it is in talks with Japanese telco Softbank about a potential deal that could see Softbank assuming a majority stake in Sprint. [1] Although Sprint warned that a sale wasn’t assured, it did say that the negotiations involve a “potential substantial investment by Softbank in Sprint”. How much Softbank was willing to pay has not been ascertained but rumors put the deal at worth $13 billion for a two-thirds stake in Sprint. If true, such a deal would value Sprint at over $19 billion, a premium of 25% over Sprint’s market capitalization before the rumors broke out.

While Sprint’s stock has certainly benefited from these talks, we believe that a potential deal would boost the company’s fundamentals as well, most notably its highly leveraged balance sheet. Softbank’s interest in Clearwire’s spectrum could also prop up Sprint, which plans on using the latter’s spectrum resources for additional 4G capacity down the road. We recently revised our price estimate for Sprint to about $5.30, which is slightly behind the current market price following the news. For more information about those revisions, see our article Sprint is Worth $5.30 Excluding Takeover Rumors.

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Sprint’s cost of capital could decrease

If negotiations between the two parties lead to a deal, Softbank’s financial backing could push Sprint’s value higher. Softbank’s deep pockets (it has about $13 billion of cash and cash equivalents on its balance sheet) as well as access to cheap capital could decrease Sprint’s cost of capital for future investments. This should help lower our estimates for Sprint’s discount rate as well, which is over 10% currently.

Sprint has $21 billion of long-term debt compared to market capitalization of about $17 billion which includes less than $9 billion in cash and equivalents. Additionally, the company has made an expensive $15.5 billion bet on the iPhone and is currently in the midst of a massively expensive network modernization plan and LTE rollout. Management expects that its Network Vision initiative alone will cost between $4 and $5 billion. While the iPhone deal has worked well so far, and we expect the margin benefits from Network Vision to more than compensate for the initial capital expenses, a deal with Softbank would likely make the project’s costs significantly more manageable.

Sprint could benefit from a stronger Clearwire

Another area where Sprint could potentially benefit from is Softbank’s interest in Clearwire, in which Sprint is the largest shareholder. Clearwire has a massive spectrum position in the 2.5 GHz frequency band – a frequency in which Softbank also owns a swath of spectrum – which it is using to deploy a new 4G network. Clearwire’s 4G network will utilize a type of LTE called TDD-LTE, which has gained little traction in the U.S. but is currently being used by Softbank in Japan. Getting its hands on Clearwire’s spectrum for its U.S. subsidiary is therefore important for Softbank since its networks will be compatible and should also help it secure more favorable bulk deals from network equipment suppliers and handset manufacturers.

However, Clearwire’s financial position is not strong and the carrier could run into hurdles in expanding its LTE network. A deal with Softbank would allow debt-strapped Clearwire to roll out its LTE network more rapidly, which Sprint can then use to boost its 4G coverage and capacity (though the two networks are currently incompatible). With Sprint lagging far behind AT&T (NYSE:T) and especially Verizon (NYSE:VZ) in terms of LTE coverage, this would be a huge positive development for the company.

On the regulatory front, we wouldn’t expect a potential deal to hit any major regulatory roadblocks. We expect the FCC would be pleased with a deal that would increase competition in the industry, as a Softbank investment would make Sprint more financially stable.

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Notes:
  1. Sprint confirms in talks on potential sale to Softbank, Reuters, October 10th, 2012 [↩]