One of the smartest investments this year is the acquisition of more than 80% of Sprint (NYSE: S), the third-largest carrier in the U.S., by Japanese carrier Softbank, led by Japan's third-richest person, Masayoshi Son. This investment was widely criticized by Softbank shareholders, due to Sprint's high debt. However, this acquisition could end up as a great turnaround story.
With more than $21 billion invested, Son believes his company can strengthen Sprint's competitive advantages, and create a disruptive force in the U.S. carrier industry. How does Son plan to carry out this turnaround? And what are the consequences for Sprint's main competitors Verizon (NYSE: VZ) and AT&T (NYSE: T)?
On July 11, Softbank acquired more than 78% of Sprint, paying roughly $6.90 per share, a meaningful premium.
However, because Sprint is trading now at $6.40 per share, it seems the market disagrees with Softbank about the real value of Sprint. This is probably because market is paying too much attention to the latest earnings results, while Softbank is preparing a turnaround with long-term implications.
In the second quarter of 2013, Sprint reported weak figures: 0.4% revenue growth, only 194,000 new subscribers, and a loss of approximately 1 million postpaid customers. However, Softbank is focused on the long term, and therefore short-term results are not important. How is Softbank planning this turnaround?
Since reviving Sprint is an expensive process, the first step is injecting new equity capital. One quarter of Softbank's money, roughly $5 billion, will strengthen Sprint's balance sheet. This money is already being used for strategic acquisitions. For example, Sprint acquired Clearwire, the fifth-largest wireless provider in the U.S. This move allows Sprint to use Clearwire's spectrum -- in the top 100 markets in the U.S., Clearwire has around 160 MHZ of spectrum -- to continue building out its LTE network.
With Clearwire under control and the backing of Softbank, which has vast experience with TD-LTE networks in Japan, Sprint will be able to add new markets to its LTE coverage quickly, despite having started later than Verizon and AT&T.
The next step is to make Sprint more efficient as an organization. Changes to Sprint's compensation policy -- like increasing bonuses based on subscriber growth -- and the use of various aggressive campaigns to enhance customers to change their smartphone devices as quickly as possible -- a strategy widely used in Japan by Softbank -- are set to boost revenue in the middle run. This is already happening: Sprint One Up is a marketing campaign and upgrade program launched a couple of weeks ago, where discounts are used to make customers change their devices every 12 months.
The final step involves developing and taking advantage of long-run synergies. After all, the combined value of Sprint and Softbank together is huge. Amazing economies of scale are in the making. After Sprint finishes catching up with LTE network, Softbank's CEO will probably try to negotiate better terms with hardware suppliers. These discounts will allow Sprint to offer even more aggressive pricing.
Competitors won't stay quiet
AT&T, aware of Softbank's plans, is aggressively pursuing strategic partnerships. For example, it recently contacted Telecom Italia, which hasn't been profitable since 2010, for a possible purchase. And, AT&T is also interested in Vodafone's mobile business.
Such moves may be the only way of preparing against the revival of Sprint, because the new Sprint will have more bargaining power against hardware manufacturers. According to Morningstar, half of AT&T's retail customers use iPhones. If Softbank and Sprint manage to negotiate better terms with Apple, and therefore provide a better pricing for iPhones, AT&T could lose considerable customer base.
Verizon won't stay quiet either. With more than 100 million retail customers, $116 billion of sales last year, and covering more than 95% of the U.S. whole market, its wireless division is the leader in the industry and a magnificent cash cow. Just in the latest quarter, wireless revenue grew by 7.5%. Moreover, Verizon's using its cash to invest in technology and acquire peers like Vodafone and, more recently, Canadian wireless carrier Wind Mobile.
Final Foolish thoughts
Due to the enormous benefits that economies of scale provide against hardware sellers in terms of infrastructure maintenance and bargaining power, the carrier industry is becoming increasingly compact. Only a few carriers are set to survive. Sprint could be among them, because its turnaround plan has a long-term focus on developing competitive advantages.
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