Capital and lots of it: That’s always been the key to success in global communications, and now more than ever.
Companies that can spend money on their networks are able to adopt the best technology and accommodate the most lucrative customer relationships. Those that can’t are increasingly forced to undercut the market by competing on price, as their networks fall behind.
Almost from the time telecom deregulation officially launched in the mid-1990s, Sprint (NYSE: S) has lagged industry leaders in the great capital race. Today, burdened by some $24 billion in debt and billions more in obligations to Apple (NSDQ: AAPL) to buy iPhones, its capital shortage is more acute than ever, and it’s ability to compete equally dubious.
Last week, I noted the nation’s No. 3 wireless carrier had once again been left out of a deal to help it achieve scale. That was the move by Deutsche Telekom’s (GR: DTE, OTC: DTEGY) T-Mobile USA to join forces with MetroPCS.
If the deal is consummated as expected, the combined T-Mobile/MetroPCS will be able to compete much more effectively in the pre-paid wireless market, where management intends to aggressively pursue a tiered pricing model. The new entity will be well situated to eventually overtake Sprint, which has also taken an interest in the prepaid market to offset losses in the more lucrative post-paid contract market.
As a result, Sprint’s plight was once again brought into graphic relief. And management has apparently decided that desperate times call for desperate measures. Its prescribed course: aligning with No. 3 Japanese wireless carrier Softbank Corp (JP: 9984, OTC: SFTBY).
There’s nothing in the books yet. In fact, the 17 percent drop in Softbank stock following the rumors of a deal may eventually discourage it from acting.
But based on the details of a potential union that have been leaked so far, Softbank would take a majority stake in Sprint, possibly as much as 75 percent. That in turn would provide Sprint with badly needed cash to meet current commitments, as well as what’s required to keep up with the likes of AT&T (NYSE: T) and Verizon (NYSE: VZ)–who at this point each spend more than four times what Sprint can on networks.
The rumor of a deal sent Sprint’s shares higher this week. It also lifted long-suffering shares of affiliated broadband company Clearwire (NSDQ: CLWR), on speculation Sprint would buy it out. That’s also likely helped Comcast (NSDQ: CMSCA) today, as it still owns 13 percent of Clearwire.
The long-term track record of foreign telecoms investing in the US, however, isn’t so encouraging. For example, Deutsche Telekom’s T-Mobile USA was essentially acquired for $35 billion in 2001 as Voicestream Wireless. After 10 largely disappointing years, it tried to unload the company to AT&T for $39 billion, but was turned back by the Federal Communications Commission (FCC) and is now trying to preserve value by spending even more. T-Mobile USA, meanwhile, is worth only about one-fourth of what it was a decade ago.
Softbank’s in-country rival NT&T (NYSE: NTT) also tried its hand at US expansion and failed. In 2001 and 2002, it invested $10.2 billion in what was then AT&T Wireless, but was later forced to abandon the effort and essentially write off the investment due to evaporating margins and soaring costs.
Of all the foreign telecom partnerships in the US, Vodafone’s (NYSE: VOD) 45 percent stake in Verizon Wireless ranks as the clear success story. But it too has had difficulty realizing the return on its investment, as majority owner Verizon has utilized its management control to continue reinvesting most capital in the business, rather than paying out dividends as a minority investor would prefer.
Ironically, the most positive aspect of this deal is on the regulatory side. For one thing, there’s a well-worn path toward approving this kind of deal. But the Obama Administration FCC’s 3-2 Democratic majority has also demonstrated a clear bias toward encouraging the maximum number of competitors in the US wireless industry. And it’s anxious to prop up a flailing Sprint as a result.
Any deal will have to be constructed with US legal ramifications in mind, particularly if Softbank does wind up taking a majority stake. But the speculation is regulators will act relatively quickly to keep Sprint afloat.
If a deal can be forged, it will be very bullish for Sprint’s estimated 40,000 or so employees, who otherwise face almost certain long-term attrition. It’s also bullish for Sprint bondholders. S&P has put the company’s B+ rating on credit watch with implications for a possible boost in rating just because there’s speculation that there will be a deal. And we’ve already seen a rally of sorts in several Sprint bond issues, including almost 10 percent today for the 9.25 percent notes maturing April 15, 2022.
As far as the stock goes, however, I can’t help thinking about Chrysler’s experience as a perpetual No. 3 in the auto industry, and its attempt to seek a foreign savior. In other words, even if a deal goes through and Sprint does have considerably more capital at its disposal, there’s still a lot of ground to make up with AT&T and Verizon. And given management’s misallocation of capital in the past–case in point, the now written-off assets of the former Nextel and floundering investment in Clearwire–there’s no assurance any cash will be put to good use.
Then there’s the question of just how much ownership Sprint’s current shareholders will have to give up to get Softbank’s cash. A 75 percent stake for Softbank, for example, basically means current shareholders would have one-fourth the ownership stake in the company they do now.
On the plus side, Sprint is hardly expensive: Its shares trade at just 50 percent of sales, or less than half the multiple of Verizon and less than a third of AT&T. And since Wall Street is typically focused on the short term, any deal that emerges is likely to get a lot of people very excited, which should push the stock higher still in addition to the gains it’s already made this year.
As far as I’m concerned, however, Sprint still needs to prove it can execute over the long term. Until that happens, even the most generous investment by Softbank is best viewed as a temporary stay of execution for a company that’s repeatedly disappointed anyone who got too close to it. The best communications plays for anyone but a speculator are elsewhere.