Before You Bet on Telecom Consolidation
While Sprint PCS's growing woes appear to set it up as the catalyst for a merger wave, they'll more likely only slow it down
Wireless-industry investors sensed that the Feb. 23 Chapter 11 bankruptcy filing by iPCS, a subsidiary of AirGate PCS, was more than just another business failure. An affiliate of Sprint PCS (PCS ), the nation's No. 4 wireless service provider, iPCS exclusively markets the carrier's products and services in its territory and allows Sprint's 17.8 million mobile users to roam iPCS's network, stretching through parts of Illinois, Michigan, Iowa, and eastern Nebraska. After initially sending Sprint PCS 2% lower, to $3.92, on Feb. 24, investors later began to see good news in the filing. The Street now decrees that the iPCS bankruptcy could actually herald the start of the long-anticipated wireless industry consolidation.
Here's how that argument goes: Sprint PCS can't let its 12 mostly ailing affiliates die, four of which are publicly traded -- Alamosa (APS ), UbiquiTel (UPCS ), AirGate PCS (PCSA ), and US Unwired (UNWR ) -- and could default on their debt, says Marcus Jones, an analyst with Moody's Investor Service. So, Sprint PCS would have no choice but to bail them out, fall deeper into debt itself -- and, with interest payments looming, become a willing bride. That would kick off consolidation, in which the Big Six wireless carriers -- Verizon Wireless, Cingular, AT&T Wireless (AWE ), Sprint PCS, Nextel (NXTL ), and T-Mobile -- would morph into three to four companies.
Then, price competition would subside. The industry's profits would rise. And stock prices would finally go skyward.
FRAGILE BALANCE. Reality could go 180 degrees the other way, however. Rather than spark a merger wave, Sprint PCS's woes could actually slow it. Suitors will likely want to wait to see just how much Sprint PCS, already burdened with $18 billion in long-term debt, would have to spend to prop up its affiliates, says Andrew Cole, an analyst with wireless consultancy Adventis.
The amount could be substantial. Its publicly traded affiliates have amassed $3 billion in debt, estimates Rick Black, an analyst with Blaylock & Partners. But Sprint PCS's credit rating is only a notch above junk, and adding any more debt or spending any hefty amounts to bail out its affiliates can tip its fragile balance. Sprint PCS is indeed in a tight spot: It receives 12% of its revenues from affiliate fees, but it likely realizes little profit from them, according to Andrei Jezierski, a partner with tech consultancy i2 Partners in New York.
The complaint iPCS filed with the bankruptcy court on Feb. 24 fueled investors' speculation that Sprint might soon have to fork over cash to buy iPCS. In the filing, iPCS alleges that Sprint PCS violated its affiliate agreement by putting the smaller partner in a position where it couldn't make any money. iPCS demands that Sprint PCS buys it at 88% of its market value -- hundreds of millions of dollars, according to iPCS Chief Restructuring Officer Tim Yager -- or nurses iPCS back to health.
"Sprint has reviewed iPCS's complaint and believes it is without merit," says a Sprint PCS spokesperson. "iPCS's financial problems are due to its debt load and have nothing to do with Sprint's actions." Analysts now mostly agree, and say proving Sprint PCS is at fault will be difficult, if not impossible for iPCS.
DARK NETWORK? That doesn't mean, however, that Sprint PCS will get to save its money. It will still likely have to offer support to iPCS and other affiliates, or its image with customers will suffer, says Jeff Kagan, a telecom industry analyst. The affiliates support 2.6 million mobile users, most of whom, because of how affiliate marketing works, don't even know about iPCS and assume that they're Sprint's customers. Though iPCS hopes to emerge from bankruptcy in as little as six months and plans to continue supporting its customers in the meantime, the possibility still exists that its network could go dark -- and that would be disastrous for Sprint PCS.
It's also possible that, as the smaller outfit tries to cut costs, its network quality would suffer, says Kagan. If that happens, iPCS's 235,000 users would blame Sprint PCS. The same would be true for customers of any other affiliates whose troubles deepen. "The first shoe has dropped," says Kagan. "I just hope it's not an octopus."
iPCS's troubles likely mean that Sprint PCS has lost some of its bargaining power and no longer qualifies for a merger of equals, says Kagan. It would more likely be acquired, instead. Or if no acquirer could be found, in a worst-case scenario it might have to sell off parts of its network, he says. Sprint PCS declined to comment on industry consolidation. Despite this situation, with $3 billion in cash and equivalents as of Dec. 31, Sprint PCS's parent, Sprint Corp. (FON ), should have no liquidity problems this year, says Jim Veneau, a senior analyst at Moody's Investor Service.
EXTRA SPECTRUM. To a buyer, Sprint PCS does have a lot to offer. It has a new, state-of-the-art nationwide network, while some other carriers are still building out theirs. Its system allows for major cost efficiencies in handling customer calls. Sprint PCS claims that these efficiencies are much greater than those for AT&T Wireless's network, for example. Unlike many rivals, Sprint PCS also has some extra spectrum, used to send calls, which could come in handy for future expansion. The spectrum is a major asset, valued at billions of dollars.
However, potential buyers could be leery. While Verizon Wireless, the nation's largest wireless provider, could be eyeing Sprint PCS because both use the same network technology, it might hesitate to assume that $18 billion in debt and the possibility of even more. After all, Verizon Wireless's parents, telecoms Vodafone (VOD ) and Verizon (VZ ), are struggling to lighten their own debt loads.
Ditto for Baby Bells SBC Communications (SBC ) and BellSouth (BLS ), which have $30.7 billion in combined debt as of the end of 2002. They have a joint-venture in No. 2 wireless service provider Cingular, but if they ever were to part ways, one could keep Cingular, while the other could shop for a wireless business that offers faster growth than its traditional landline concern, say Kagan. Since BellSouth has been involved in a legal battle with Sprint PCS's parent over a top executive, it might have severed the two companies' relationship. That would leave SBC as a possible buyer.
HOW ABOUT 2004? A long-distance company like AT&T (T ) or even WorldCom, which could emerge from bankruptcy within weeks, might want to invest in a faster-growing, wireless business, says Kagan. Still, for WorldCom, Sprint's mountainous debt and the uncertainty surrounding its affiliates might be the last things it needs as it tries to regain its footing.
Looking at the industry's landscape from this perspective, consolidation announcements, originally expected this year, might not happen until mid-2004, says Craig Mathias, founder of wireless consultancy Farpoint Group. So, investors who expect iPCS's bad news to turn into good any time soon may want to think again.