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Fitch: Sprint/T-Mobile USA: Bigger is Only Better with Execution

A key factor in determining the long-term success of a potential Sprint Corp./T-Mobile USA merger will be the combined company's ability to produce a wireless network on par with the industry leaders in terms of coverage, density and overall network quality, according to Fitch Ratings.

Sprint Corp. and T-Mobile USA are reportedly nearing a transaction in which Sprint will acquire T-Mobile for approximately $32 billion. The combined companies would be of comparable size to Verizon and AT&T from a subscriber point of view, thus providing the necessary scale for improved operational efficiency and profitability to better sustain competition over the long term.

A Sprint/T-Mobile union would improve the network densification required for a higher-speed wireless offering, but would also likely add further integration challenges to Sprint's already lengthy network migration plans, Fitch believes. Sprint's poor operational performance in the past, combined with a lack of capital investment and aging infrastructure, resulted in a growing competitive disadvantage as network quality and speed lagged the industry, particularly as Verizon and AT&T accelerated deployment of 4G services.

Recent network initiatives to improve Sprint's competitive position and 4G service levels has been slow and resulted in elevated churn levels due to the significant network disturbances related to the modernization project. Further capital investments to leverage Sprint's high band 2.5 GHz spectrum advantage will require at least another couple of years as Sprint attempts to improve its national service offering to the level of its peers.

Additional challenges persist. A combination of the two companies would require a regulatory review process with strong potential for litigation, as well as an extensive integration period. T-Mobile carved out a compelling niche in the marketplace during the past year with its "un-carrier" strategy that has resonated with consumers and would be the stronger brand to leverage going forward. Sprint Chairman Masayoshi Son envisions a combined company that could eventually go head-to-head for wired home broadband services, although given the magnitude of such a plan, timing is uncertain. As such, Fitch believes that under parent company Softbank's direction, the combined entity would need to substantially improve the execution of future strategic initiatives to compete more effectively against Verizon and AT&T.

Regulatory approval remains a substantial hurdle for this potential transaction. The FCC and DOJ have made explicit comments regarding their desire to maintain a wireless marketplace with four operators as fewer competitors could result in increased risk of higher prices and decreased innovation. Thus any transaction would be judged on the merits of whether the public's best interests are served and if material antitrust elements are present.

Sprint's chairman has argued that the combination would be an effective counterweight against the growing size of Verizon, AT&T and Comcast that has been bolstered through continued consolidation. Both AT&T and Comcast are attempting to amass more scale with $40+ billion merger reviews before the FCC and DOJ. A combination of Sprint and T-Mobile would result in a direct competitive overlap in a concentrated wireless market. However, it may be unsustainable for the third and fourth wireless operators to remain independent over the longer term as the bulk of the wireless industry revenues and cash flows are concentrated between two much larger players.

Predicting an outcome of a regulatory review for a potential Sprint and T-Mobile combination is difficult given the current regulatory climate. However, regulatory approval of a Sprint/T-Mobile merger would likely require substantial concessions and related divestitures to address public interest concerns and antitrust issues. These could include material 2.5 GHz spectrum divestitures, a substantial commitment to meaningfully participate in the broadcast TV auction, attractive 4G wholesale service commitments, further obligations to support rural partnerships and timeline/milestone dates associated with market deployments targeting home wireless broadband service.

The impact of a potential T-Mobile acquisition on Sprint's pro forma credit profile depends on numerous factors, including but not limited to the overall transaction funding strategy, incremental investment in Sprint by Softbank and anticipated cost synergies. Fitch's working case assumes an equity purchase price of $40 per share for a transaction value of approximately $32.1 billion. Fitch assumes the transaction is funded with a mix of Sprint common stock (50% of transaction value), no incremental investment by Softbank and approximately $16.1 billion of incremental debt issued by Sprint. In this case Fitch estimates that Softbank's pro forma ownership of Sprint would dilute to approximately 57% from 81%. Additionally a modest $2 billion in annual cost synergies is assumed in the base case.

Fitch expects Sprint, as it exists today, to leverage cost reduction efforts that will lead to margin expansion and a stronger overall financial profile. Leverage peaked at 6.1x during 2013 and Fitch anticipates leverage will decline to the low 5x range by year-end 2014. In Fitch's view a potential T-Mobile acquisition could likely delay the anticipated recovery of Sprint's credit profile.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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