Key Takeaways:
· The entire Sprint/Clearwire/Dish/SoftBank situation is very complicated.
· We believe SoftBank’s offer makes more sense for Sprint’s near-term future.
· However, we like the well-rounded package that a combined Sprint/Dish entity would be able to offer consumers over the long haul, and we tend to have faith in skilled managers like Dish’s CEO Ergen.
· In any case, we think the saga will eventually result in a winner’s curse—whoever wins the battle for Sprint will likely have paid too much!
· Ideas
o One industry in particular would be highly in favor of SoftBank’s deal with Sprint—the networking equipment makers. If Sprint receives a huge capital infusion from a SoftBank deal, network upgrade spending would accelerate. Cisco (CSCO) is our favorite fundamental idea in the networking-equipment space, though shares have converged nicely to our fair value range.
o Verizon (VZ) is our favorite dividend-growth idea in the space on the basis of its excellent Valuentum Dividend Cushion score (2.1). Please click to download its dividend report.
o We hold DirecTV (DTV) in the portfolio of our Best Ideas Newsletter on the basis of valuation. The firm registers a rare 9 on our Valuentum Buying Index, our stock-selection methodology.
During the past several months, the battle for control of Sprint (click ticker for report: ) and Clearwire (CLWR) has evolved into one of the largest bidding wars of the year. Let’s take a look at the parties involved.
The Participants
Sprint
Sprint is in an enviable position as it now possesses bids from Japanese wireless carrier SoftBank and Dish Network (click ticker for report: ). It originally seemed that SoftBank had the inside track since it worked out a friendly deal with existing management. However, Sprint is now considering delaying the vote on the deal in order to give Dish more time to figure out exactly how it wants to handle the situation. The outlook for Sprint could differ greatly depending on who the owner is.
The SoftBank offer (as it stands) would bolster Sprint’s financial health and competitive position via a cash infusion and a likely acquisition of Clearwire (though Dish’s offer price for Clearwire is the highest at the time of this writing). Add in the fact that SoftBank recently boosted the offer for Sprint to $21.6 billion (was $20.1 billion), a SoftBank/Sprint tie-up looks attractive for Sprint shareholders. The current deal on the table gives SoftBank 78% of Sprint (was 70% previously), but it does reduce the capital infusion (to Sprint) to $5 billion (was $8 billion), since more cash will now be going directly to Sprint shareholders ($16.6 billion compared with $12.1 billion previously).
Interestingly, the deal lowers the total estimated value of Sprint by $1.1 billion ($28.8 billion to $27.7 billion), which has confused the matter for Sprint shareholders (though having more cash today could be viewed as the major sweetener behind the revised offer).The poison pill provision in the newly-proposed SoftBank/Sprint transaction also gets tougher to swallow, increasing from $600 million to $800 million if Sprint sides with Dish, the latter also having a proposal on the table to acquire Sprint.
SoftBank could extend a helping hand in building Sprint’s nationwide LTE network. In order to become a formidable foe to Verizon (click ticker for report: ) and AT&T (click ticker for report: ), Sprint will need to spend tens of billions of dollars upgrading its current network. The fight gets even more difficult since the competition is already spending tens of billions of dollars to improve their own network speeds and capacity.
Under Dish ownership, Sprint’s future is less certain. Sprint has a long way to go in terms of service quality to be able to compete with the industry heavyweights. Dish will need to take on substantial financial leverage to complete a transaction with Sprint, so we’re not sure the newly-combined entity would have enough financial flexibility for sufficient network investments. We also aren’t sure Clearwire would be part of this new company, since it could look to default or sell itself to another bidder. Sprint may eventually have to offer upwards of $4.50 per share to give shareholders of Clearwire a fair deal (the Dish proposal is currently at $4.40 per share). However, we think the newly-combined entity could offer a unique product, cross-selling phone, internet, and satellite services.
In either case, Sprint’s free cash flow growth will be constrained by capital investment over the next several years. This is one of the reasons why we do not think shares look attractive (the main one is that the stock currently reflects a rather large buyout premium), though we admit Sprint could receive yet another higher bid. Our tentative view is that Sprint will eventually be a part of SoftBank, even though SoftBank has also talked with T-Mobile (TMUS) about acquiring a stake in it, too (a Plan B, so to speak).
Clearwire
Clearwire’s future is the most difficult to predict, in our view. It all started with a $2.97 per share offer for the company from Sprint way back in December. The proposal seemed like a slam-dunk because shares of Clearwire had been depressed for some time, but Dish came in with a far superior offer for Clearwire of $3.30 per share in January. Sprint then came back to Clearwire with an offer of $3.40 per share on May 21, sparking Dish to came back again later in that month—this time offering $4.40 per share and some additional financing for all of the outstanding shares of Clearwire (though the company indicated that it did not necessarily expect Sprint to tender its shares).
Throughout the entire process, Clearwire’s board has recommended that shareholders accept the deal from Sprint. And that is where the situation currently stands. We think Clearwire’s board is in an awkward situation. On one hand, selling to Sprint is the easy way out. Sprint already owns 50% of the company, and the future of the spectrum assets is not in question. On the other hand, Clearwire has an obligation to shareholders to get the best deal possible, and agreeing to a buyout with Sprint when Dish’s offer is 29% higher seems like a breach of duty (even if Dish may not be able to utilize the spectrum assets as well as Sprint would). Assuming Dish fails to acquire Sprint and/or Clearwire, it could pave the way for Dish to acquire one of the other mobile carriers such as T-Mobile (Dish’s Plan B looks very similar to SoftBank’s).
Clearwire also has an ace in the hole: default. In the event of a default, it is possible existing debt holders could be paid off, with value remaining for shareholders. While we think an event of default is highly unlikely, it could potentially set off an open-market bidding war for spectrum assets that could even fetch a higher premium than what could be provided by a publicly-traded suitor. Clearwire is still making debt payments at this time, however.
Regardless of what happens, Clearwire’s destiny will be materially impacted by Sprint’s future course. If Sprint falls into the hands of SoftBank, we could envision Dish’s CEO Charlie Ergen launching an even more aggressive campaign for Clearwire. If Dish successfully merges with Sprint, then we doubt the bid for Clearwire would increase. Either way, we’re not interested in Clearwire given the current risk/reward, which we believe is titled against new investors.
Dish
Now that the satellite business is mature in the US, Dish’s Ergen continues to look for transformative opportunities. Never one to shy away from debt, Ergen appears committed to acquiring spectrum and eventually entering the wireless carrier space. Ergen’s track record speaks for itself—Dish’s stock has outperformed the S&P 500 2,059% to 204% since going public in 1995.
The issue we have with a Dish/Sprint tie-up is the amount of capital investment necessary to upgrade Sprint’s network. The combined entity will be highly levered, and we aren’t sure if the higher ARPU (average revenue per user) provided by combining services would offer enough incremental cash flow to cover necessary near-term capital expenditures while rewarding shareholders sufficiently.
We think merging with Sprint is a risky proposition for Dish, but Ergen’s cost discipline and fantastic ability to allocate capital could make the deal work. Nevertheless, we think a Dish/Sprint alliance would be weaker in the near-term than a Sprint that’s able to sustain heavy capital spending with a cash injection from SoftBank. It may be telling that Dish refused a $3 billion reverse breakup fee, perhaps revealing that the company may not be completely serious about getting a deal with Sprint done.
We believe shares of Dish look fairly valued, and in our view, DirecTV (click ticker for report: ) looks like the more attractive idea—in fact, we hold shares of the latter in the portfolio of our Best Ideas Newsletter. The firm also registers a rare 9 on our Valuentum Buying Index, our stock-selection methodology.
The Impact
Networking Equipment Makers
One industry in particular would be highly in favor of SoftBank’s deal with Sprint—the networking equipment makers. Both Cisco (click ticker for report: ) and Ciena (click ticker for report: ) announced positive earnings on the strength of continued capital spending from the wireless carriers. If Sprint receives a huge capital infusion from a SoftBank deal, network upgrade spending would accelerate, benefitting the aforementioned companies, as well as firms like Juniper (click ticker for report: ) and Finisar (click ticker for report: ). Cisco is our favorite fundamental idea in the networking-equipment space, though shares have converged nicely to our fair value range.
If Sprint merges with Dish, network upgrades may be delayed or constrained by heavy interest payments, which wouldn’t be as positive for the network equipment providers.
Wireless Carriers
Though the wireless industry continues to consolidate, heavy capital spending continues to limit significant free cash flow expansion at industry giants AT&T and Verizon. We note, however, that