Sprint Corp (NYSE:S) and T-Mobile US Inc (NASDAQ:TMUS) called off their merger over the weekend. Sprint, the fourth largest carrier in the U.S., behind Verizon Communications Inc. (NYSE:VZ), AT&T Inc. (NYSE:T) and T-Mobile, now faces new challenges.
Sprint must now find a way to survive and prosper on its own without the help of a competitor. The failure of the merger implies government regulators want a fourth carrier to remain in business.
Considering the financial realities and competitive pressures, however, holders of S stock will likely not benefit.
Sprint Hit After Merger Dies
T-Mobile canceled its merger with Sprint as it became apparent that its holding company Softbank Group Corp (OTCMKTS:SFTBF) and T-Mobile’s parent company, Deutsche Telekom AG (OTCMKTS:DTEGY) would have to sell too many of its assets to gain U.S. government approval.
This announcement left the S stock price falling to a fresh 52-week low, losing as much as 15% of its trading value in Monday’s trading session as it becomes apparent that Sprint must face a multitude of financial problems on its own.
Debt and Revenue Issues Plague S Stock
My colleague Laura Hoy, who correctly predicted the failure of the merger, cites Sprint’s debt as a serious issue. Long-term debt levels stand at above $37 billion as of the last earnings report. This debt presents a financial threat to a company with a market cap of around $23 billion. That debt level isn’t necessarily a death blow. However, the debt could hamper the company’s ability to confront other issues.
One ongoing challenge remains the company’s earnings. Sprint has not produced positive earnings for several years. Though most analysts forecast an end to the losses by 2019, problems remain. If consensus earnings per share (EPS) predictions hold up, S stock will earn 11 cents per share in 2020.
Unfortunately for current shareholders, that places the price-to-earnings (PE) ratio at over 50 times 2020 EPS. Morningstar predicts a quicker path to positive earnings. However, they estimate the forward PE at over 330! Both indicate S stock has much further to fall to settle at a PE ratio that’s more in line with S&P 500 averages.
The limited pathways to increase revenue and profits remain a concern. Sprint has often tried to lure more subscribers by offering lower prices. However, changing products and shorter product life cycles have forced carriers to find creative inducements to retain customers.
Sprint’s now former suitor T-Mobile offers free service from Netflix, Inc. (NASDAQ:NFLX), for example. Additionally, competitors have also kept service costs low to retain and attract customers.
A Necessary 5G Upgrade Will Be Costly
An extension of the competitive battles involves improving service. As a result, Sprint faces a costly upgrade to 5G wireless technology to keep up. 5G offers tremendous benefits such as service that’s 10 times faster than 4G. The service will also provide greater reliability with less power consumption.
Accenture estimates the new technology could add $500 billion to the U.S.’s gross domestic product (GDP). Sprint could reap a substantial share of that $500 billion with a successful 5G upgrade.
The bad news for holders of S stock is the cost of the upgrade. The exponential increase in data transmission means building multiple small cells.
Instead of maintaining one large tower every few miles, the company will have to install dozens of small cells simply to cover a neighborhood. Upgrading to 5G technology will cost the industry hundreds of billions.
With its debt burden in the tens of billions, Sprint will struggle to finance its part of the 5G upgrade. Of course, Sprint would also offer 10 times the speed with 5G. Unfortunately for holders of S stock, it’s unlikely to result in 10 times the revenue, or anything close to that.
Given the Trump administration’s apparent desire to give Americans a fourth choice in wireless providers, Sprint may get a 5G network built. However, the company may have to unburden itself of its debt in bankruptcy to make this possible. Obviously, bankruptcy remains the worst-case scenario for current holders of S stock.
Due to its high debt, competitive pressures, and a costly 5G upgrade needed soon, Sprint faces formidable challenges. On the competitive front, Sprint is forced to charge lower fees and offer more benefits to retain and attract customers.
Additionally, the high cost of a 5G upgrade could force the company into bankruptcy simply to keep up. Hence, the risk of holding S stock outweighs any potential rewards a comeback could provide.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.