How Far Will SoftBank Go To Close A Sprint – T-Mobile Deal?

by Trefis Team
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There has been increasing speculation regarding a merger between Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) since the U.S. Presidential election, given the possibility of a more conducive regulatory environment for telecom mergers under a Republican establishment. Last week, in an interesting development, Reuters reported that Sprint’s parent firm SoftBank would be willing to cede control of Sprint, effectively becoming a minority stakeholder, in order to facilitate a merger between the two companies. While SoftBank has yet to approach T-Mobile’s parent Deutsche Telekom to discuss a deal, on account of the FCC’s ongoing spectrum auction and the related anti-collusion rules that forbid discussions between rivals during the auction period, there is a possibility that the carriers could begin negotiations after the auction concludes in April.

See our complete analysis for  Verizon | AT&T |T-MobileSprint 

We have a $7.50 price estimate for Sprint, which is 20% below the current market price. Meanwhile, our $64 price estimate for T-Mobile is roughly in line with the current market price.

Sprint May Need A Merger To Guarantee Long-Term Viability

While Sprint tried to acquire T-Mobile back in 2014, it had to back off after some opposition from the U.S. Department of Justice. However, things have changed significantly since then. T-Mobile’s financial position has improved considerably, as it overtook Sprint to become the nation’s third-largest carrier, amid strong subscriber growth and improving profitability. The carrier’s market cap has also more than doubled since then, rising from around $25 billion to about $52 billion currently. Sprint, on the other hand, continues to face challenges, despite some operational improvements and subscriber additions. Sprint’s free cash flows are only expected to break even this fiscal year, and its net debt has risen to over $31 billion, up from about $26 billion in 2014. Much of this debt is high yield, and the carrier has had to resort to mortgaging assets to meet its liquidity needs. Competition has also been mounting in the U.S. wireless market amid price cuts, the re-emergence of unlimited plans across carriers and increasingly compelling equipment offers, indicating that operating margins could remain under pressure in the interim.

Under current circumstances, SoftBank likely thinks that it would be better off losing control of Sprint as long as it is able to get a deal done, as a merger would deliver significant cost synergies, improving shareholder value. Moreover, such an arrangement would enable SoftBank to free itself from the burden of turning around a loss-making, second-tier wireless carrier, allowing it to focus on its other growth plans. For instance, the conglomerate recently bought British chip designer ARM, while teaming up with Saudi Arabia and other investors to form a $100 billion technology investment fund. SoftBank Chairman Masayoshi Son has been laying the groundwork for Sprint’s deal-making ambitions, building relations with the new Presidential Administration by committing to invest about $50 billion from its investment fund in the U.S., creating around 50,000 new jobs.

Deal Would Deliver Significant Value For Both Parties

To be sure, T-Mobile is likely to have greater bargaining leverage if negotiations between the carriers begin. However,  shareholders of both companies should benefit meaningfully from a deal. Running a wireless network calls for high fixed costs and at a base level, these costs are independent of the number of subscribers that a carrier has. Moreover, these costs are typically higher for U.S. carriers, given the country’s large geographic area, which calls for a greater number of cell sites. During 2016, T-Mobile incurred cost of services expenditures of roughly $5.7 billion, while Sprint’s cost of services stood at about $8 billion. In comparison, Verizon‘s (NYSE:VZ) wireless cost of services stood at under $8 billion, despite the fact that its wireless customer base (~112 million subs) is almost as large as Sprint and T-Mobile’s combined. Savings relating to sales, marketing and support could also be significant.

If we assume that the combined entity is able to cut total costs by around $1 billion for the first year post-closing, with cost savings coming in at $2 billion in year two and remaining at ~$3 billion from year three to perpetuity, the present value of synergies after tax (assuming a 35% tax rate and 9% discount rate) would stand at roughly $20 billion. This could add considerable value for shareholders of both companies, while improving their debt and interest coverage ratios. Moreover, a merger could foster a stronger pricing environment in the wireless market – although this aspect of the deal is likely to be downplayed by both firms given the regulatory concerns.

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