Should You Buy on This Opening Bid?

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Leap Wireless (NASDAQ: LEAP) exploded with gains of 117% during Friday’s afterhours trading, once AT&T (NYSE: T) disclosed that it will be paying $1.18 billion for Leap’s equity and is assuming its $2.8 billion in debt.

While many are trying to understand the implications of this acquisition, I am looking to determine if it’s a good deal, and how it benefits AT&T.

Is The FCC Waiting To Reject?

Immediately following the acquisition news, Twitter was lighting up with people saying that the FCC would deny the purchase. Remember, the FCC blocked the AT&T/T-Mobile acquisition last year, saying it presented an “unfair advantage” and that it would harm consumers with lost jobs.

What these people obviously don’t realize about the AT&T/Leap acquisition is that it’s not nearly as big. The AT&T/T-Mobile acquisition would have made AT&T head-and-shoulders above all others in the space. Take a look below to better understand:

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>Subscribers (millions)</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Verizon</p> </td> <td> <p>115</p> </td> </tr> <tr> <td> <p>AT&T</p> </td> <td> <p>107</p> </td> </tr> <tr> <td> <p>Sprint</p> </td> <td> <p>55.6</p> </td> </tr> <tr> <td> <p>T-Mobile</p> </td> <td> <p>43</p> </td> </tr> <tr> <td> <p>America Movil</p> </td> <td> <p>23.23 in U.S.</p> </td> </tr> <tr> <td> <p>U.S. Cellular</p> </td> <td> <p>5.8</p> </td> </tr> <tr> <td> <p>Leap (Cricket)</p> </td> <td> <p>5.3</p> </td> </tr> </tbody> </table>

AT&T combined with T-Mobile would have given AT&T more than 160 million subscribers, which would have been significantly larger than #1 Verizon. However, with Leap, AT&T gains just 5.3 million subscribers, and is still the #2 wireless provider. Therefore, I see no reason why the FCC would block the acquisition.

Why Is It Important?

While many want to look at the synergies of AT&T acquiring Leap’s Cricket and the implications of AT&T’s comments “growing Cricket”, we all know why AT&T is buying Leap: Spectrum!

As I have explained before, spectrum in the wireless arena is similar to an interstate for transportation. If you’ve ever been to Atlanta, Georgia (or any other congested American city), you know that when all eight interstate lanes are open, traffic moves freely, but when there is construction and only three lanes are open, you may sit in traffic for many hours.

Spectrum is like the interstate, it allows data to move freely, and the more spectrum a company has, the better its network performs. Leap may only have 5.3 million subscribers, but it has a spectrum that covers 137 million people. Clearly, most of this spectrum is unused, which means that AT&T can use it for 4G buildouts – especially in urban areas. As a result, there is great value in this acquisition for AT&T.

Is It A Good Acquisition?

If you are wondering whether or not AT&T is making a good acquisition, just look at what Sprint (NYSE: S) paid to acquire Clearwire.

Unlike, Leap, Clearwire is not a wireless provider. Thus, Sprint does not gain the 5.3 million subscribers that are gained by AT&T acquiring Leap. But what Sprint is gaining with the acquisition of Clearwire is spectrum.

Clearwire’s spectrum covers 4G to 130 million people in 80 different cities. This gives Sprint the ability to significantly grow and expand its network. However, as I already mentioned, Leap’s spectrum has the capability to cover 137 million people. This doesn’t mean that Leap’s spectrum is better, as Clearwire’s spectrum could almost certainty expand as well, but the two are similar nonetheless.

Leap closed the after-hours session at $17.31, which represents a market cap of $1.37 billion – significantly higher than the $1.18 billion offered by AT&T. The reason that Leap is trading above the offered price is because investors assume that the bid will rise. This is especially true following the Clearwire war, where a $2.75 bid turned into a $5 a share buyout. Let’s see how the two acquisitions compare:

<table> <thead> <tr><th> </th><th> <p><strong>Clearwire</strong></p> </th><th> <p><strong>Leap</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Purchase Price</p> </td> <td> <p>$3.5 billion</p> </td> <td> <p>$1.18 billion</p> </td> </tr> <tr> <td> <p>Revenue</p> </td> <td> <p>$1.26 billion</p> </td> <td> <p>$3.1 billion</p> </td> </tr> <tr> <td> <p>Operating Margin</p> </td> <td> <p>(109%)</p> </td> <td> <p>(1.64%)</p> </td> </tr> <tr> <td> <p>Debt-To-Assets Ratio</p> </td> <td> <p>59%</p> </td> <td> <p>68%</p> </td> </tr> </tbody> </table>

As you can see, Leap is more worthy of the $3.5 billion buyout price, while I wouldn’t pay $100 million to acquire a company with fundamentals like Clearwire. However, in the chase for spectrum, high prices will be paid.

Final Implications

If AT&T does in fact acquire Leap, then I say it is a great buy. AT&T has struggled as of late to effectively build its network into urban areas. The reason this is important is because urban buildouts are already established, and face more regulatory challenges versus those in rural areas. This simply has to do with supply and demand, as the FCC prefers spectrum to be spread out. However, by acquiring Leap, AT&T would gain an established spectrum with large use capabilities, which would be one more selling point to both consumers and investors. Hence, it makes the company's growth outlook more attractive.

In regards to Sprint, the company now has the support of Softbank to swallow any mistakes that Sprint might make. However, the Clearwire acquisition itself, I don't like it. I understand that spectrum is valuable, but I don't like Clearwire's underlying business. With that said, Sprint is still nowhere near profitable, and operates with a debt-to-assets ratio of 50%. Back in 2012, Sprint was my 'Value of the Year," but after a 200% return, I don't really see the upside.

The only way that I believe Clearwire adds value is if you are a Leap investor. Clearwire created a bidding war, and it is very likely that Leap could see a similar reaction to AT&T's opening bid. Perhaps Dish bids for Leap, like it did with Clearwire, or maybe even Verizon comes to the table? Either way, Leap is a far more attractive company compared to Clearwire, and for this reason, I find it hard to believe that there are no other suitors prepared to respond with a bid of their own.


Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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