A Warren Buffett or John Malone Investment Would Help Sprint, But Also Raise Questions

While shareholders of Sprint Corp. (S) ended last week with euphoria with reports suggesting that Warren Buffett or John Malone could take a stake in the wireless carrier, the hangover may set in Monday as shares gave back some of those gains. 

Shares of Sprint dropped 1.4% to $8.43 on Monday, after rallying 4.3% Friday on news of the talks.

Attracting funds from such esteemed investors could address some of Sprint's woes as it seeks to merge with T-Mobile USA Inc (TMUS) . However, they would not be a panacea and could actually raise concerns for the number four wireless carrier. 

For starters, why would Sprint Chairman Masayoshi Son sell rather than invest himself? Son, who runs Japanese telecom and technology power Softbank Corp, is raising $100 billion through his Softbank Vision Fund, attracting such deep-pocketed investors as Apple Inc. (AAPL) , Qualcomm Corp. (QCOM) and the Kingdom of Saudi Arabia.

A $10 billion to $20 billion investment from Buffett, as reported, would represent 23% to 37% of Sprint's equity, BTIG LLC's Walt Piecyk noted in a Monday report, reducing Softbank's more than 80% position.

"The stock would gain some credibility, but Masa is undoubtedly one of the most respected, credible investors/operators of this era," Piecyk observed. "He just raised nearly $100 billion to invest as he sees fit from high profile companies like Apple and Qualcomm. Why does he need Buffett's money or credibility and, more importantly, why is he selling?"

Looking past the question of whether Buffett would actually make such an investment, the investment could help Sprint pay down some of its debt.

The carrier's balance sheet is an impediment to a T-Mobile USA merger, MoffettNathanson LLC analyst Craig Moffet suggested in a Monday note.

Sprint reported $35.8 billion in debt in May, which exceeds its market cap of $34.6 billion. When adjusting for capitalized leases and other items, Moffett writes, Sprint's comes to 6.1 times Ebitda, compared to a ratio of 4.0 for T-Mobile. 

"[I]ndeed, it may well be that a T-Mobile deal would only be possible if Sprint's balance sheet were first completely restructured, either through bankruptcy or a massive injection of new equity," Moffet wrote.

A large equity investment could complicate a merger, however. The combined Sprint and T-Mobile would have an equity value of $87 billion, which Moffett suggests reflects the savings and other benefits from a merger with T-Mobile USA. But the merger could produce an "unwieldy combined equity valuation that couldn't be supported with current synergy estimates," leading to the stocks "falling rather than rising" if a deal were announced.

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So where is the upside for investors such as Buffett and Malone, if the price of the companies already reflects the synergies? Moreover, what happens if regulators reject a merger?

"[W]hile an infusion of outside equity would certainly relieve the pressure on Sprint to quickly strike a deal with T-Mobile, it is hard to imagine that anyone would want to make a big equity investment without a deal," Moffett wrote. 

"Unless an equity infusion in Sprint can be done at well below the current market, diluting current equity holders," he added, "Warren Buffett and John Malone would effectively be underwriting all of the risk that the merger would be rejected (and the synergies therefore lost)."

That doesn't sound like the smart play that investors such as Buffett and Malone typically make. 

If nothing else, Wells Fargo Securities LLC analyst Jennifer Fritzsche noted that the talks do have a positive message.

"In our view, Softbank is doing exactly what is should be doing have multiple conversations with multiple parties," she wrote, suggesting that Sprint can meet its near-term debt maturities and is not negotiating "from a position of weakness." 

The talks with Buffett and Malone may ultimately send a message to merger partner T-Mobile USA and parent Deutsche Telekom AG: We have options.

The reports of the latest talks may remind investors of reports that Sprint held talks with Comcast Corp. (CMCSA) and Charter Communications Inc. (CHTR) . Those discussions turned out to be about a mobile resale agreement rather than about an equity investment.

Unless the talks with Buffett and Malone turn out to be more substantial, the message to T-Mobile USA and Deutsche Telekom won't carry much weight.

Sprint declined to comment. Buffett's Berkshire Hathaway Inc. (BRK.A) and John Malone's Liberty Media Corp. (FWONA) did not respond to queries. 

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