4 Reasons to Fear Sprint

The market clearly likes the chances of Sprint Nextel (NYSE: S  ) acquiring Deutsche's 67% stake in T-Mobile, valued at around $20 billion. On December 13, the Wall Street Journal reported the news, and shares of Sprint have since soared nearly 35%. While increasing the size of Sprint would help its competitive edge against Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) , there are four reasons in particular why investors might want to sell.

The FCC is a question mark
Two years ago, the FCC blocked AT&T's proposed acquisition of T-Mobile. The reason given was that it would hurt the competitive landscape, affect pricing, and cause job losses.

Combined, AT&T and T-Mobile would have created more than 150 million subscribers, which is far more than Verizon's 107 million. Moreover, and most importantly, it would have reduced the number of nationwide carriers from four to three, hence affecting free market.

If Sprint was to acquire T-Mobile, the combined number of total subscribers would be under 100 million, far fewer than either Verizon or AT&T. Furthermore, regarding post-paid subscribers only, Sprint/T-Mobile would have just 53 million, versus 95 million for Verizon and 72 million for AT&T.

Yet, despite the fact that Sprint and T-Mobile combined would be smaller in size, it would still lower the number of nationwide providers from four to three, which was a primary issue for the FCC when it rejected AT&T's offer.

For this reason, investors should tread carefully, as Sprint's 35% gains since December 13 are reflective of this bid and can be lost if the deal fails to materialize.

A breakup could be a hold up
AT&T unwisely offered, and then had to pay, T-Mobile $7 billion as a breakup fee when its acquisition attempt was blocked by the FCC.

At the time, the proposed fee was considered a sign of good faith and confidence on behalf of AT&T. Breakup fees with companies of this size are commonplace, but this hasn't been discussed openly as it relates to Sprint's offer.

SoftBank CEO, Masayoshi Son, will try to avoid a $7 billion breakup fee, especially considering what happened with AT&T. However, Sprint and Deutsche will have to agree on a fair price, possibly $3 billion-$5 billion. If the acquisition is blocked by the FCC, either for competitive reasons or because the FCC simply doesn't want a Japanese company controlling such a large U.S. telecom company, then Sprint will have to pay out the cash.

Hence, billions would be removed from Sprint's $7.5 billion cash position and given to Deutsche, making this a win-win bid for T-Mobile.

Watch out for DISH
As Softbank is well aware, DISH's  (NASDAQ: DISH  ) Charlie Ergen can be one pesky Chairman when he wants something, and Ergen desperately wants to make use of DISH's 4G spectrum.

Spectrum is very important for communication companies, as it allows for the smooth travel of data. DISH owns a large spectrum, one that was recently approved for mobile usage by the FCC, but the company has no mobile business. Thus, Ergen has tried relentlessly to outbid and out-strategize Softbank in acquiring both Sprint and Clearwire.

Therefore, it should come as no surprise that Ergen is considering a bid for T-Mobile, according to Reuters. If DISH could acquire T-Mobile, it could offer customers both TV and wireless services, which would boost its top-line growth and could be done cheaply since the spectrum is already in play.

Ergen's involvement is a big risk for Sprint, a company that faces a much higher risk of FCC backlash versus DISH.

Priced for perfection
Lastly, to determine upside based on valuation relative to its peers, take a look at a few key metrics of Sprint compared to AT&T and Verizon:

 

Sprint

Verizon

AT&T

P/E Ratio

N/A

64

25.75

Forward P/E Ratio

N/A

14

13.1

Operating Margin

1.23%

14.66%

9.58

Price/Sales

1.11

1.18

1.45

2013 Sales Growth Estimate

(0.9%)

4.1%

1.8%

2014 Sales Growth Expectations

1.2%

3.8%*

1.9%

*Not incorporating acquisition of Verizon Wireless

It should come as no surprise that Sprint is not expected to be profitable this year or next, hence the company's P/E and forward ratios.

Sprint's operating margin compared to its peers shows the company's lack of efficiency relative to its industry. Also, Sprint is seeing slowed growth for 2013 and lackluster growth for 2014.

With Sprint being unprofitable and disconnected from its peers in every fundamental metric possible, the only way to compare the three with a single metric is with price/sales. Currently, Sprint trades with a very similar multiple to Verizon, while AT&T has a 30% premium.

Yet, Verizon and AT&T are light years ahead of Sprint, with their profitability, balance sheet strength, margins, growth, and dividends. Sprint should trade at a massive discount to its peers, not a comparable multiple. Therefore, this in itself presents a risk, as Sprint is essentially overvalued, or priced with peers that are far better companies.

Final thoughts
Sprint's recent 35% gain is in connection to the T-Mobile rumors, but due to its valuation, the stock is very vulnerable to potential losses if all dominoes don't fall in place.

Investing in Sprint is risky at the moment, and it appears as though all upside has been priced into the stock. Unfortunately, the company must still cross many hurdles, and this fact signals the potential for significant downward pressure. Be very careful investing in Sprint.

Editor's Note: SoftBank is a Japanese company, not a Chinese company. This version has been corrected and Motley Fool apologizes for the error.

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Read/Post Comments (8) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 30, 2013, at 11:55 AM, ande1416 wrote:

    "If the acquisition is blocked by the FCC, either for competitive reasons or because the FCC simply doesn't want a Chinese company controlling such a large U.S. telecom company, then Sprint will have to pay out the cash."

    Softbank is not a Chinese company, it is Japanese.

  • Report this Comment On December 30, 2013, at 12:30 PM, Aku603 wrote:

    Ande1416 good catch there.

    I don't call this an article, more like a blog.

  • Report this Comment On December 30, 2013, at 1:21 PM, rebecakane wrote:

    Sprint is an international company with major business in Europe and around the world. It would be foolish not to invest with them. Sprint has Boost Mobile and other non-contract services which has become a huge trend internationally. When it comes to prices for their service, it is the best for the $, having people who can do the math go with their service instead for the usual ATT and Verizon. The Chinese comment . . . typical American foolishness. Just because of that you lost your credibility.

  • Report this Comment On December 30, 2013, at 1:29 PM, BrianNichols wrote:

    ande, my apologies. It was a mistake on my part. Thank you

  • Report this Comment On December 30, 2013, at 4:16 PM, guajirogringo wrote:

    Chinese - Japanese... what's the difference, eh. i can think of a dozen reasons to fear Sprint right about now, if you're holding a short position. Good luck with that Mr. Nichols.

  • Report this Comment On December 30, 2013, at 4:51 PM, guajirogringo wrote:

    "If the acquisition is blocked by the FCC, either for competitive reasons or because the FCC simply doesn't want a Chinese company controlling such a large U.S. telecom company, then Sprint will have to pay out the cash."

    Of course CEO Son, who is a Japanese businessman of Korean descent (no "Chinese" there), would likely make his bid contingent on FCC approval. With 80% of the float locked up, this is a very dangerous short play. A successful merger could easily drive shares over $30.

  • Report this Comment On December 31, 2013, at 6:17 AM, MSFInvestments wrote:

    The synergies in M Son's other partnerships with Sprint will be massive. There is much more to Sprint than meets the eye. Remember, you are dealing with M Son here. I do not think he would go through all this just to be rejected and pay fees.

    Sprint will be at least $25.00 in 2014.

    Lahiem

  • Report this Comment On December 31, 2013, at 2:17 PM, weepingwillow123 wrote:

    I remember this author, Brian Nichols buying Sprint at low 2's and selling around 6's. I also remember him telling people not to buy Sprint at that time. Well, look where Sprint PPS is today. Guess he is little sore for missing out on the boat, and/or just trying to sell his book. I read part of his book, and nothing useful in that book either. Softbank is a Chinese company? LOL

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