Sprint (S) – Merger Renegotiation (Short) – 12% Upside

Current price: $8.52

Expected Takeover Price: $7.5

Upside: 12%

Renegotiation date: TBD

Press release on judge’s approval

This idea was shared by Dan.

 

A bit of speculative trade expecting renegotiated price for TMUS/S merger.

Yesterday, on the 11th of Feb’20 judge Victor Marrero has refused a request by 14 attorney generals to block the T-Mobile/Sprint transaction. As a result, Sprint stock has jumped up by almost 80%. The only remaining approval (California Public Utilities Commission) is likely to be received. Nonetheless, Sprint is trading at a 14% spread to merger consideration (originally at 0.10256 TMUS shares for each Sprint share), which indicates that there are expectations that price will be renegotiated. I think it is indeed very likely that the price will be amended. So far it seems likely that the market might be understating the actual size of the cut. TMUS CEO has already hinted about the possible renegotiation several times and there are weighty arguments to support this move.

Overall, this seems like an attractive opportunity to short Sprint, which will end up profitable if the consideration gets trimmed by at least 14% (or c. 8% for the EV basis) and it looks like such outcome is quite likely. Valuing Sprint’s equity at the same absolute dollar amount as in mid 2018, would result in merger price of $6.5/share (might be a bit too aggressive, so I included $7.5 as a target).

As the long stop date for the combination has now passed, both companies are now free to walk away from the merger which significantly increases TMUS negotiating leverage.

Keep in mind that this is a large cap transaction that is widely followed by crowds of professional arbitrageurs, so Mr. Market might be fully correct on this one and the $8.5/share might turn out to be a correct estimate of the renegotiated price.

 

Poor Sprint’s Financial Performance

Assuming merger terms remain unchanged, due to increase in TMUS share price Sprint’s equity would be valued at $38.5bn vs. $26.5bn equity valuation at the time of merger announcement. However, during 1.5 years (and especially over the last two quarters) the performance of Sprint has been quite poor and has definitely lagged that of TMUS:

• Revenues are shrinking. Dec’19 TTM revenues are down 4.5% YoY. Performance of the wireless segment for last 3 quarters was also went down: Q1 -1%, Q2 -7% and Q3 -6% YoY.
• Churn is largest among the peers and is consistently getting worse.  Year to date postpaid customers churn has increased to 1.87% from 1.75% last year. Recent quarter (Dec’19) showed 1.98% vs 1.74% in Mar’18, before the announcement of the merger.
• ARPU (average revenue per user) is consistently falling down. In the recent quarter postpaid ARPU was $42.02 and $29.63 for prepaid vs $44.40 and $37.10 respectively at the time of the announcement.
• The company also keeps losing its postpaid phone (second largest segment) subscribers. For the last year Sprint has lost on average 130k subscribers per quarter.

Besides that Sprint also got into trouble recently when FCC has found out that the company was falsely collecting monthly subsidies ($9.25/user) from the government’s Lifeline program for the 885k subscribers, who were actually inactive and not using the service. Sprint explained that it was a result of an error after the FCC implemented new rules in 2016. The exact penalty is not clear yet, however it may potentially squeeze out up to several hundred million dollars from Sprint.

In comparison, TMUS had a much better performance even if the growth has gradually slowed down:

• TMUS has remained continuously profitable and in ’19 saw its net income increase by 20% YoY.
• For the last 7 quarters revenues are growing by 5% on average.
• Churn seems to be quite stable. Latest results showed postpaid customers churn at 1.01% and prepaid at 3.97%  vs postpaid 1.07% and 3.94% for prepaid at the time of the merger announcement.
• ARPU is also relatively stable – $45.79  and $38.54 (postpaid/prepaid) vs $46.66 and $38.9 at the announcement.

Looking at this divergence in financial performance it is hard to find arguments that would justify keeping the same exchange ratio in the merger, let alone explain why the Sprint equity should be valued at 45% premium relative to initial announcement (aside from overall bullish performance of U.S. stock market). Downward price trend in Sprint’s share price till yesterday’s announcement paints a similar picture – the stock traded below the pre-announcement price ($4.3/share vs ~$5+/share in mid 2018) despite the fact that there was still some chance that the merger might close successfully (implying that the actual standalone equity value of Sprint would probably be around $2-$3 /share).

TMUS might not agree to pay significantly more for the deteriorating financial performance than the valuation in the initial agreement or $6.5 per Sprint share.

 

Comments on Renegotiation

The comments about the lower price started appearing back in July’19, when it was reported that the companies are renegotiating the price after the concession requirements from DOJ/FCC. However, the exchange rate has eventually stayed the same.

In Nov’19 commenting about the negotiations with Softbank (Sprint’s owner) TMUS CEO has stated that he doesn’t rule out lowering the acquisition price.

Then in Dec’19 Fox Business has again reported rumors on renegotiations.

During the last week’s conference call the CEO has again stated:

I’m going to take one of the write-in questions, one of the 72 that Walter Piecyk has sent in because I think there was some confusion on this point by a number people. He says the merger agreement – meaning with Sprint – was never updated. Does that mean that any change in deal price is off the table?

A number people were confused. When the long stop date of the business combination arrangement agreement came on 11/1, the BCA was still in effect. We have a fully in effect BCA. But at 11/1 without an amendment, either party has a walk away right. So, in effect, the partnership is still strong, we just have not updated it to remove the walkaway ability.

And, no, it doesn’t mean that we can’t. We’ve had a very strong partnership with Sprint. We’ve had very good discussions. And if there is a need for an amendment to the BCA, including possibly a price, we would handle that very swiftly after the deal was approved. So, I hope that explains the nuance there.

It is also important to note that Softbank is in a weak spot for negotiations as after the recent failure with WeWork, Softbank is apparently struggling to raise money for its new fund. It has been looking to drop the highly leveraged (over $30bn debt) Sprint that constitutes ~10% of the portfolio for a number of years now, but given the current situation the incentives should be especially strong.

 

Additional Risks

• The merger is not done yet and has to be approved by California Public Utilities Commission (CPUC). 18 public utilities commissions have already approved the transaction, so the chances are high that California will also give its blessing. Nonetheless, in 40 years (source) seems that CPUC is one of the most active utility commissions regarding the communication mergers, so there is still some risk that CPUC might hurdle the merger or at least ask for additional concessions etc.
• 14 attorney generals, who went to court asking to block the transaction might file an appeal again impeding the merger. This option has not been rejected so far and AG Letitia James has indicated that the group might not be done fighting yet.