iPhone Causes Sprint Deal Hang-Ups (Update 1)

Updated with analyst earnings estimates and afternoon share prices.

NEW YORK ( TheStreet) -- Apple ( AAPL) may be taking a bite out of Sprint's ( S) acquisition ability as the nation's third largest carrier tries to digest a spectrum partnership with Clearwire ( CLWR) and hunt for deals to grow its subscribers.

In October Sprint announced a $15.5 billion four year deal to carry the iPhone and keep pace with its larger competitors AT&T ( T) and Verizon ( VZ). That deal -- and a commitment to improving smartphone services through a program called "Network Vision" and a multi-billion dollar 4G build with Clearwire -- may be the reason that Sprint's board reportedly iced a $7.3 billion acquisition of MetroPCS ( PCS).

Sprint Chief Executive Dan Hesse was "hours away" from announcing a deal to buy MetroPCS until the board vetoed the acquisition last Wednesday, according to Friday reports by CNBC. Analysts now say that while an acquisition of MetroPCS and its pre-paid cellular service competitor Leap Wireless ( LEAP) are likely in the user and service growth starved wireless industry, Sprint's expensive commitment to Apple and Clearwire made a deal untenable in the near-term.

Sprint's inability to cut a deal, taken with weaker than expected fourth quarter industry profitability may signal that wireless carriers are struggling to find returns on surging iPhone sales, which drove record quarterly profit at Apple. The Sprint deal also may highlight new reasons why failed consolidation is a possible industry game changer, even as analysts and investors expect 2012 deals.

"As the failure of this transaction makes clear, Sprint's ability to play the consolidator role is highly uncertain, at least any time soon," writes Craig Moffett of Bernstein Research in a Monday note reacting to the failed Sprint and MetroPCS tie-up. That's because Sprint may need billions to invest in its Clearwire 4G service build, while the company paid a hefty price to carry the iPhone. " They are burdened with a gigantic and seemingly uneconomic Apple contract that has already depressed margins and that is likely to continue to do so for years," adds Moffett, who has a "market weight" rating on Sprint and an "overweight" rating on MetroPCS shares, with $2.50 and $13.00 price targets, respectively.

Still, according to analyst price targets Sprint and Clearwire are two wireless plays with high risk and reward on their success of a now closer-tethered spectrum partnership.

Sprint and Clearwire shares rose in Monday afternoon trading to $2.56 and $2.15, respectively. Sprint shares are up roughly 10% year-to-date but have dropped over 40% in the last 12 months, while Clearwire shares have posted a similar 2012 gain to go with a near 60% stock drop in the last 12 months.

Content on this page requires a newer version of Adobe Flash Player.

Get Adobe Flash player

That drop in valuation may make the companies positioned for 2012 gains, if closer ties help the wireless partners achieve analyst price targets. Sprint warrants a $3.18 price target and Clearwire shares are valued at $3.33 a share, according to consensus analyst estimates compiled by Bloomberg.

Those expectations of an over 25% possible gain contrast to more established, high dividend paying industry players like Verizon and AT&T, who's stock's trade in-line with analyst price targets. Meanwhile, Leap Wireless shares jumped over 5% to $11.23 -- past analyst price targets of $10.67 - on news of the MetroPCS deal fail.

Still, Sprint's deal fail and recent Clearwire struggles expose huge risks for both companies, as the industry faces profitability threats. Both Sprint and Clearwire reported big 2011 losses, capping a string of unprofitable years that isn't expected to end anytime soon.

Sprint's revenue is expected grow over 4% to $35.1 billion in 2012 as its annual loss narrows from nearly $3 billion to $934 million, according to consensus estimates of analysts polled by Bloomberg. That loss is expected grow back to near $3 billion in 2013, even as sales continue to grow. Meanwhile, Clearwire is expected to lose roughly $500 million in 2012 and 2013, according to analyst estimates.

Before reports surfaced that a $7.3 billion deal for MetroPCS consisting of $5 billion in Sprint stock and $2.3 billion in debt had fallen apart after months of negotiation, Sprint faced the prospect of additional funding for Clearwire that may grow its $20 billion-plus debt stock.

On Friday, Google ( GOOG) said it would sell its 2.1% stake in Clearwire shares, opening the possibility that other investors in the WiMAX giant like Comcast ( CMCSA) and Time Warner Cable ( TWC) would also sell their stakes, which total roughly 5% of outstanding shares. In December, those companies signed a $3.6 billion spectrum sale and marketing agreement with Verizon, possibly minimizing their need for Clearwire capacity.

"Should all of the other strategic investors sell - a prospect that looks more like a "when" than an "if" - it will be even harder for Sprint to maintain the fiction that Clearwire is not simply a Sprint subsidiary," says Moffett. On Monday, Sprint sold $2 billion in debt with the stated purpose of funding Clearwire, its debt service and network expansion.

While a MetroPCS deal would have blended well with the company's underlying CDMA technology, the merger would hinge on pre-paid wireless user growth, not spectrum gains, notes Moffett. Still, he expects MetroPCS and Leap Wireless takeove interest. "With or without a Sprint deal, these companies remain viable targets for larger carriers."

"We view today's announcement by Sprint and Clearwire to be a positive development for both companies since it indicates that they are working together more closely to try to harmonize their strategies and critical network upgrades," wrote Moody's of the debt offering, maintaining its "ratings review" on Sprint's B1 rating.

Sprint's shares have suffered over uncertainty on its Clearwire strategy and its ability see returns on investments like selling Apple iPhones. "AT&T and Verizon are the only two companies in the U.S. wireless industry that will earn enough to cover their cost of capital "wrote Moody's in a Feb. 13 note that highlighted a Sprint and MetroPCS tie-up as a possibility.

"Investors are already walking away, making it harder for the carriers to attract capital to keep pace," added Moody's. In a separate note, Moody's also said that the dimming prospects of LightSquared, an alternative spectrum network being built by hedge-fund Harbinger Capital may increase the cost for Sprint to go all-in on its Clearwire partnership, as its options decrease.

With the inability to raise significant debt and huge spending commitments, a MetroPCS acquisition would have required Sprint to rely on its low-priced stock, potentially making a deal uneconomic.

Sprint's prospective deal for MetroPCS was likely involve huge amounts of stock, potentially diluting by 50% at a time when Sprint's stock of $2.40 isn't far off record lows. "Investors are already being asked to fund a ~$15bn commitment to Apple in order to sustain postpaid market share. A potential MetroPCS deal, which may have cut equity holders' stakes in half to get larger in the prepaid business seems a bit incongruent with the strategic direction," writes Nomura analyst Mike McCormack in a Monday note.

The now reportedly stalled MetroPCS deal also raise questions about Sprint's existing Clearwire and Apple deals. In December, Sprint upped its investment in Clearwire to $1.6 billion with Monday's debt offering signaling a possible increased ownership push. Meanwhile, in fourth quarter earnings, Sprint reported bringing on 720,000 iPhone subscribers, short of initial projections of roughly 1 million.

"We wonder if Friday's news is indication that Network Vision, iPhone, or core operations are not developing as Sprint had hoped. It is highly likely that the deal was an attempt to secure cash generation through Sprint's current transition phase," says McCormack.

In fourth quarter earnings, Sprint reported its largest quarterly loss in three years as iPhone-driven subscriber growth cut profit margins. With the iPhone, Sprint added 161,000 net postpaid subscribers during the quarter, ending a run of three consecutive quarters of net postpaid losses in 2011, but the Overland Park, K.S.-based company posted a $1.3 billion loss.

Apple iPhones are also creating growing headaches at Sprint's larger rivals like Verizon and AT&T. Fourth quarter earnings showed that while revenue and smartphone sales grew dramatically on iPhone and Android sales, bottom-line profitability missed estimates, signaling a continued profitability pressure.

For Sprint, the MetroPCS deal drama may raise questions about whether its Board of Directors and Chief Executive Dan Hesse are moving in different directions.

"Having a deal brought by management rejected by a Board of Directors this late in the process is a rare situation and may suggest the two are not on the same page," wrote John Hodulik of UBS in a Monday note. While Hodulik understands Sprint's interest in the synergies and cash flow that would come from a deal, the timing seemed off as the company is still absorbing projects like "Network Vision."

Like in any deal, timing and capital is just as important as strategy. While many analysts came out in support of the long-term benefits of a Sprint and MetroPCS tie-up, they saw company's existing capital commitments to Apple, Clearwire and other aspects of its network growth as overwhelming a deal. "Later though, we believe a deal would be accretive for both companies and a positive for the wireless industry, and this almost-deal could be an indication that Sprint eventually could be a consolidator," wrote Philip Cusick of JPMorgan.

In the interim, consolidation is still one of the driving forces for carrier stocks and their forward earnings, after $39 billion 2011 merger between AT&T and T-Mobile USA was scuttled by antitrust regulators. Sprint may focus on a more spectrum focused deal like a stake increase in its Clearwire or a partnership with T-Mobile.

Meanwhile, AT&T may recast its M&A ambition on DISH Network ( DISH), to grow its spectrum. Michael Rollins of Citigroup counts "AT&T eventually buying DISH and Sprint improving its strategic position by either connecting with T-Mobile USA (in a merger or network sharing deal) or buying up regional players," as the most likely M&A scenarios. ". Within the regional carrier group, we believe Buy-rated Leap represents the most compelling balance of a relatively low spectrum value, licensed use of mainstream spectrum bands," he adds.

For more on the wireless industry, see why AT&T is still hungry for more spectrum and how a tower deal twists industry consolidation. For more on M&A, see 5 deal ready stocks loved by hedge funds.

-- Written by Antoine Gara in New York

Readers Also Like:

If you liked this article you might like

Verizon and Yahoo! Sports Bring Super Bowl LII to the Small Screen

Verizon and Yahoo! Sports Bring Super Bowl LII to the Small Screen

These Stocks Are Showing Resiliency Amid the Market Selloff

These Stocks Are Showing Resiliency Amid the Market Selloff

Stocks Slide and Amazon's Profit Soars - 5 Things You Must Know

Stocks Slide and Amazon's Profit Soars - 5 Things You Must Know

5 High-Growth Tech Stocks for 2018

5 High-Growth Tech Stocks for 2018

Goldman Exec Swindled out of $1.2 Million in Vintage Wine: LIVE MARKETS BLOG

Goldman Exec Swindled out of $1.2 Million in Vintage Wine: LIVE MARKETS BLOG