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Sprint Corp Is a Deal for Customers, But S Stock Is a Dud

S stock has held its ground while the sector slumps, but that could lead investors to misplaced optimism

Sprint Corp (NYSE:S) has unleashed a bold promotional move. It’s great for new customers; Not so much for S stock holders.

Sprint Corp Is a Deal for Customers, But S Stock Is a Dud

The company is offering a year of unlimited wireless service to new customers. Anyone with a competitor’s smart phone can get unlimited texting, calls, and data if they switch to Sprint. The pitch is aimed at Verizon Communications Inc. (NYSE:VZ) customers but it’s likely to cause fallout across the whole sector.

If stock prices are any guide, Sprint’s pricing strategy is indeed raising investor concerns. VZ stock has slumped, off 23% from last July’s highs. AT&T Inc. (NYSE:T) has hardly fared better; its shares have dropped 15% since March and sit near 52-week lows.

Sprint’s shares, however, have bucked the trend. S stock soared from $3 to $9 in 2016. This year, trading has been generally flat; Sprint has held its ground while the sector slumps. Unfortunately, this optimism could be misplaced.

Why Sprint Is Heading for a Merger

As the smallest and financially flimsiest of the four major mobile carriers, Sprint finds itself in a difficult competitive position. The company continues to lose money, while sector leaders AT&T and Verizon are wildly profitable. Scale is a real asset in the wireless business, and Sprint simply isn’t big enough to be maintain a strong financial position.

This has led investors to conclude that S stock will inevitably be acquired by another player with a stronger balance sheet. T-Mobile US Inc (NASDAQ:TMUS) would be a likely suitor; Both have suggested that they are interested in merging.

However, T-Mobile has a dominant negotiating position. Its business has surged. Over the last five years, TMUS has grown revenues 50%, while Sprint sales have remained flat. Sprint’s debt has ballooned to $41 billion from $24 billion over that period.

Meanwhile, the company continues to lose money and burn cash. Those losses, paradoxically, make a merger more likely. Sprint would serve as a massive tax shelter for a profitable acquirer, who could use the accumulated losses to offset future tax liabilities on profits.

Merger synergies aside, with the major investment required to roll-out a 5G next-generation network, Sprint needs access to more capital. Wireless companies need tons of cash, but Sprint has already largely burned through its borrowing capacity without turning a profit or making significant market share gains. Moody’s only rates Sprint’s debt as B2, which is pretty far down into junk bond territory. The company will struggle to remain viable in the long-run as an independent company.

Pricing War Could Intensify Weakness

One of the issues for Sprint is that there are no guarantees that the FTC would approve a tie-up with T-Mobile, as it would merge the country’s #3 and #4 mobile carriers. The pro-merger argument says that neither T-Mobile nor Sprint is all that strong in comparison to AT&T or Verizon, and thus the market would benefit from having a more durable #3 competitor. However, T-Mobile’s has excelled in recent years. The argument that it can’t compete against the big dogs on its own isn’t convincing.

Sprint could argue that it is too financially weak to survive on its own. But its actions, particularly in instigating a brutal price war with Verizon, speak to a company that is still capable of bringing a competitive fight. Given that the FTC prefers lower prices and more competition within industries, why would they want an aggressive Sprint that is already shaking up pricing to be swallowed up by a competitor?

Many investors assumed that a Trump administration FTC would make a potential S-TMUS deal much more likely to come about. However, investors in S stock should think through the alternatives in case a deal doesn’t occur soon.

Who Else Might Buy Sprint?

Rumors surfaced recently that cable companies may want to buy Sprint. Possible suitors could include Charter Communications, Inc. (NASDAQ:CHTR) or Comcast Corporation (NASDAQ:CMCSA). Speculation has it that the cable companies might want to do a wireless spectrum deal with Sprint, instead of buying the company outright.

This makes intuitive sense. Cable companies face mounting pressures due to cord-cutting. A wireless deal would allow a cable operator to more easily bundle internet into packages on a nationwide level, helping stem customer losses. Unlike the other major carriers, Sprint has a ton of available spectrum capacity, a rare benefit of not being able to attract enough customers. Selling this off to the cable operators would help relieve Sprint’s cash flow problems and perhaps make it a viable standalone entity again.

The Problem For S Stock

Unfortunately for S stock owners, these merger scenarios aren’t all that likely to produce big gains. The market has already factored in the perceived high probability of a near-term merger or deal. Just look at the run in S stock last year, even while operating performance was just so-so.

But the clock is ticking. Sprint has lost at least $1.2 billion dollars each of the past five years — and oftentimes much more than that. The company is bleeding cash and debt is piling up by the billions each year to keep funding necessary investments in their network and technology. Now throw in one of the most aggressive pricing wars in industry history, and Sprint will see losses accelerating.

Given Sprint’s already weak position, the faster it loses money, the more counterparties will be able to drive a hard bargain at the negotiating table. Sprint is talking about its unlimited plan as redefining wireless. And it may well do that. But if the company can’t afford to provide the service, shareholders are unlikely to benefit.

Given the drubbing that T stock and VZ stock are taking this year, it seems particularly risky for Sprint, which has questions about its solvency, to drive down the whole industry’s profit margins.

The best way Sprint can deliver shareholder value at this point would be to negotiate a fair deal quickly. The longer they sit on the merger block, the less value they are likely to get from an eventual buyer. A risky price war is the last thing they need at this point. It’s great news for customers, but don’t be surprised if S stock reacts poorly in coming quarters. With the stock up so much and a merger already largely priced-in, risk is to the downside here.

As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2017/07/sprint-corp-is-a-deal-for-customers-but-s-stock-is-a-dud/.

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