Sprint Needs to Resist the Urge to Merge
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If George Santayana were still alive, he would surely be going short on Sprint-Nextel (NYSE: S).
Santayana was the Spanish philosopher who observed that, "Those who cannot remember the past are condemned to repeat it." At a recent press conference, Dan Hesse, the Chief Executive Officer of Sprint-Nextel, predicted that the telecommunications industry is likely to undergo a series of mergers and acquisitions as companies look to beef up operations to take on AT&T (NYSE: T) and Verizon Communications (NYSE: VZ). In that regard, he stated that Sprint-Nextel is looking to buy!
While Sprint-Nextel is up 133.33% for 2012, it still has not recovered from the $36 billion merger of Sprint and Nextel Communications back in 2005. As noted on February 8, 2012 by Roger Cheng, Executive Editor of CNET News, a high tech blog, "Nextel merged with Sprint in one of the most ill-advised deals in corporate history, with consequences of the disaster still apparent seven years later. Today, the company reported yet another unprofitable quarter. Nextel, which at one point had nearly as many customers as Sprint, has been nothing but a financial, operational, and strategic distraction for the company."
And now less than 8 months later Sprint-Nextel is looking to repeat the same mistake.
The share price of Sprint-Nextel stock actually rose on Hess declaring that Sprint-Nextel was considering two types of transactions. One would be of the magnitude to challenge Verizon Communications and AT&T. The other would be to acquire a smaller entity that would immediately yield synergies, cost benefits and other positive developments.
About transactions such as these with those types of goals, Anand Chokkavelu of the Motley Fool wrote in The 100 Things I've Learned in Investing: "Mergers and acquisitions are overrated. Somewhere between 50% and 85% of mergers fail to boost value. The frequency of achieving promised synergies should be filed somewhere between unicorns and no-hitters."
The rise of Sprint-Nextel over the last year can largely be attributed to the success of the iPhone and its relationship with Apple (NASDAQ: AAPL), not any operational genius on the part of the company. Sprint-Nextel stock plunged after a disastrous press conference last October. It was downgraded by three analysts within a 24-hour period. There has been a tremendous surge recently in the share price of Sprint-Nextel in anticipation of the success of the iPhone 5, surging 74.44% for the last quarter alone.
But that cannot mask the myriad of defects on the balance sheet and income statement of Sprint-Nextel. First of all, Sprint-Nextel is losing money. The company has a negative profit margin 15.54%. Yes, selling the iPhones have lifted certainly lifted the share price of Sprint-Nextel, but it is paying a dear price for the privilege of partnering up with Apple. If Sprint-Nextel hopes to challenge Verizon Communications and AT&T, it must make money as the others are much more profitable, as shown by the chart below.
A huge toll is also still being extracted on the balance sheet for the total costs of the Sprint-Nextel merger. The debt-to-equity ratio of Sprint-Nextel is 2.30. To put the union of the two entities into perspective with the current financial state of the company, it was a $36 billion deal back in 2005; and the current market capitalization of Sprint-Nextel is less than half that at $16.38 billion. The Motley Fool's Anand Chokkavelu was certainly right about the Sprint-Nextel merger! The chart below reflects how Wall Street has also viewed the merger as manifested in the share price of Sprint-Nextel after the deal.
Due to the anticipation of the wave of consolidation in the telecommunications industry, needless to say, the share prices of potential targets have jumped, making any deal that much more expensive. Metro Communications (NYSE: TMUS), mentioned as a likely target, is up 98.41% for the quarter. Hesse would get a far better deal for the Sprint-Nextel shareholders if he did not telegraph his intentions with a flashing neon orange light that only raises the costs of any deal. Over the past month of market action, Metro Communications has jumped by 20.23%.
In addition to now having a higher share price, Metro Communications also sports a debt-to-equity ratio of 1.53. Presently losing money, Sprint-Nextel can ill afford to take on any more encumbrances on its balance sheet. The debt expenses from an acquisition of Metro Communications or another company would certainly not make a more profitable entity. Any acquisition would pose the same undesirable consequences for Sprint-Nextel and its business operations and capital structure. The chart below reveals the rising debt-to-equity ratio of Sprint-Nextel along with its negative profit margin.
As a general rule, companies that are losing money with more than $2.30 in debt for every dollar in equity should not be looking to buy. Sprint-Nextel should work on reducing its debt load rather than borrowing more and increasing its net earnings so that it actually makes money. Now is the worst time to buy in the telecommunications industry has the share prices of firms have surged and will likely remain high due to the strong sales of the iPhone 5 from Apple lifting the sector.
From that statements of Sprint CEO Dan Hesse at the recent event, Sprint-Nextel is looking to merge and/or acquire in the worst way possible. Based on the results of the Sprint-Nextel transaction, any such transactions would likely be just that for the shareholders.
Fool blogger Jonathan Yates does not own any of the stocks mentioned in this article. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. 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.If you have questions about this post or the Fool’s blog network, click here for information.