Sprint (NYSE:S) filed an application with the FCC Thursday asking for permission to go ahead with the 70% sale of stake in the company to Japanese telco Softbank. This comes exactly a month after the third largest carrier in the U.S. announced a complex $20 billion agreement, which allows Softbank to purchase 55% of its shares at $7.30 per share and infuse a total of $8 billion in cash at $5.25 per share in two separate transactions. Sprint has already received $3.1 billion in convertible debt as part of the deal and the rest of the cash transaction will happen after all the regulatory approvals have been received. The deal essentially values Sprint’s stock at about $6.38 per share, but the markets have yet not responded to the new valuation since there is a risk that the share purchase, which wouldn’t occur until mid-2013, may run into regulatory hurdles. (see What Does Sprint’s SoftBank Deal Mean For Its Stock?)
We do, however, expect the deal to be completed and approved. The cash infusion will bolster Sprint’s highly leveraged balance sheet and provide more flexibility with respect to the company’s expensive 4G LTE rollout and Network Vision initiative – as was evident in its recent $480 million spectrum purchase from US Cellular. A financially more stable Sprint will therefore be good for competition in the wireless industry and the FCC should be pleased with this development. Apart from boosting the company’s fundamentals, Softbank’s likely 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. 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 the deal receives regulatory as well as the shareholders’ approval, Softbank’s financial backing could push Sprint’s value higher.
Sprint has a huge debt load of about $21.5 billion and less than $6.5 billion in cash and cash equivalents on its balance sheet. This compares poorly to around $17 billion in market capitalization that Sprint commands. However, with the $8 billion cash infusion, the company will be able to reduce its net debt (long-term debt, excluding operating leases, minus cash) to $7 billion from ~$15 billion. As a result, its net leverage – the ratio of net debt to EBITDA – would decline from about 3x to 1.3x, possibly leading to credit rating upgrades, and as a result lower borrowing costs for the company. This should help lower our estimates for Sprint’s discount rate as well, which is over 10% currently.
Additionally, Sprint has made a big $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 long-term 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 which it will be using to launch a new 4G network using TDD-LTE in 2013. What is interesting here is that Softbank also owns a similar swath of spectrum in Japan, on which it has already launched its own 4G TD-LTE network. It will be in Softbank’s interest if it can get its hands on Clearwire’s spectrum for its U.S. subsidiary since having compatible networks will 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 the newly capitalized Sprint would allow debt-strapped Clearwire to roll out its LTE network more rapidly, which Sprint plans on using 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 could be a huge positive development for the company.