Three Ways The Sprint-Softbank Saga Could Play Out

In a letter to the Federal Communications Commission (FCC), the U.S. Department of Justice (DOJ) has asked the commission to hold off its review for the Sprint (NYSE:S)-Softbank merger. The merger is being investigated by the DOJ, the Federal Bureau of Investigation (FBI) and the Department of Homeland Security (DHS), for any potential impact on national security, public safety or law enforcement. As the matter is still under investigation, the commission has been asked not to review the merger until the investigation is complete.

In October 2012, Sprint announced a 70% stake sale of the company to Japanese telco Softbank. The complex $20 billion agreement allows Softbank to purchase 55% of Sprint 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 is to be done after the regulatory approval. The capital infusion was supposed to help Sprint close the Clearwire acquisition and put the rest towards improving its network, but the recent developments seem to have roadblocked the company’s growth plans.

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In another corporate drama earlier this month, Clearwire (NASDAQ: CLWR) announced that it received an unsolicited bid from DISH Network (NASDAQ:DISH) that topped Sprint’s offer by $500 million, coupled with an offer to buy 24% of Clearwire’s spectrum for $2.2 billion. DISH has also proposed a commercial agreement and capital assistance for Clearwire’s network build-out. DISH is offering $3.30 per share, compared to $2.97 offered by Sprint for Clearwire. This new development has impacted the plans of the newly invigorated Sprint, which has been counting on acquiring Clearwire to strengthen its bandwidth. With the delay in the Sprint-Softbank merger process and growing dissatisfaction among the minority holders of Clearwire with Sprint’s offer, there are several ways this could play out.  We discuss the three most likely scenarios below:

Scenario 1: Sprint Matches DISH’s Offer Leading To Bidding War

Sprint would be forced to revise its offer for Clearwire to match DISH. Despite Sprint owning 50% of Clearwire, the latter’s management and board have a fiduciary duty to investors and would have a hard time justifying a sale at a lower price. DISH likely has the balance sheet to mount a lengthy bidding war for Clearwire. This could force Sprint to potentially overpay, as it desperately needs the additional spectrum to successfully compete with Verizon (NYSE:VZ) and AT&T (NYSE:T). A significant additional diversion of capital to this acquisition could slow down Sprint’s aggressive growth plans and hurt its gross profit margins, which are dependent on improving operational inefficiencies.

Scenario 2: Board Rejects DISH And Approves Sale To Sprint

This would likely drag Sprint and Clearwire into a prolonged class action lawsuit by investors. The top five institutional holders own nearly 28% of outstanding shares, and could prefer DISH’s higher bid. A lawsuit could be a headwind for Sprint, which is fighting to stay relevant in the wireless market. Federal Trade Commission (FTC) intervention cannot be ruled out, as Sprint would effectively be barring a potential entrant to the highly concentrated wireless market. The FTC could even order an open auction of Clearwire’s spectrum, since Sprint’s 50% stake in Clearwire could be construed as anti-competitive.

Scenario 3: DISH Acquires Clearwire

This would leave DISH in control of significant spectrum, thanks to its recent FCC approval to use its existing spectrum for wireless service. Although rolling out a nationwide wireless service is capital intensive, this scenario would provide DISH with an upper hand when negotiating a potential partnership with Sprint or other carriers. We believe Sprint would be the most likely contender for a partnership with DISH. The terms of such a deal may be heavily favorable to DISH should it acquire Clearwire. It would be hard to predict how Softbank would respond in this scenario, since there was speculation that the Sprint acquisition is an indirect play for Clearwire’s spectrum. Softbank’s announcement of the Sprint merger wasn’t received well by many Softbank investors; should the company lose Clearwire to DISH, investors may further question the rationale behind such an expensive acquisition.

This year, Sprint plans to spend $4 billion on capital expenditures, more than what Sprint has historically spent. Moreover, Sprint is highly sensitive to CapEx increases as can be seen by moving the trend line in the forecast chart below and following the corresponding impact on its price estimate. The additional spectrum capacity could reduce future years’ capital requirements.

Irrespective of how this new development plays out, Sprint investors are likely to be jittery again after a couple of months of renewed confidence in the company.

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