Time To Revisit Cellular Merger in Pre-Paid & No-Contract (LEAP, PCS, VM, S, T, AMX, DT)

Leap Wireless International Inc. (NASDAQ: LEAP) made our volume spike alert this morning based on last night’s dismal earnings results.  But after a deeper look, there is an old reminder here that might need to be brought back up.  And the company might need to consider it.  The pending merger between Sprint Nextel Corporation (NYSE: S) and Virgin Mobile USA (NYSE: VM) creates a powerful competitor in the space of pre-paid wireless by combining operations (but not names) of Virgin and Boost.

Back September 2007, MetroPCS Communications, Inc. (NYSE: PCS) sent a letter to Leap Wireless management proposing a strategic merger that would have made it the fifth largest wireless carrier.  Based on how bad Leap’s figures were, it may be time for a revisit of what that merger might look like today.  After all, it was Leap’s turn in the barrel yesterday where its shares went roughly to $9.00 after being above $12.50 on Wednesday.

The prepaid wireless sector is very competitive.  For starters, AT&T (NYSE: T) has its GoPhone.  AMERICA MOVIL, S.A.B (NYSE: AMX) owns the TracFone.  T-Mobile is owned by Deutsche Telekom (NYSE: DT), and it offers T-Mobile To Go.  A further look at the numbers may show that the combination could be one of need rather than one of greed.

The terms of the proposed MetroPCS-Leap merger valued Leap at $69-ish to $77-ish at the time.  But it was a stock-for-stock  merger where each share of Leap common stock would be exchanged for 2.7500 shares of MetroPCS common stock.  Based upon a $8.75 MetroPCS price this morning, this would value Leap shares at $24.06. Leap’s new market cap is $1.27 billion after the drop and MetroPCS’s market cap is almost $3.1 billion.  With Leap’s stock closing at $22.59 yesterday, it would likely take a lot more than that.  Its 52-week trading range is $14.18 to $48.98.

Leap’s numbers fell short of estimates.  For the quarter, Leap’s loss was $62.8 million (-$0.89 EPS) if you include charges and expenses. Revenue  did rise by 26% to $597.4 million. Consensus estimates from Thomson Reuters were -$0.30 EPS and $636.1 million in revenue.  In the conference call after earnings, Leap’s management was candid about increased competition in the marketplace hurting its ARPUs. The reported ARPU was right at $40.73, under what many were targeting.  Price cuts and new launches may drive that down further and the company’s prior churn rate below 4.0% is noted as unsustainable and came in at 4.4% for this last quarter.

MetroPCS’s quarterly net income was down almost in half to $26 million, or $0.07 EPS on a 27% gain in revenues to $856 million.

Newer, or stronger, competition is coming from Boost, while Sprint and Virgin Mobile could have a large competitive advantage in the prepaid wireless sector.

This morning a research note from Auriga’s research said, “While the $69 per share buyout offer from MetroPCS from the summer of 2007 is now a distant memory, we believe that a deal would make sense now more than ever if for no other reason than that of expense control. A combined company would have to build only one upgraded network as the market transitions eventually to 4G. LEAP’s recent decision to raise funds suggests to us that no deal is in the works. However, we believe recent competitive changes in the marketplace could factor in any future decisions.”

Leap Wireless added more than 202,000 subscribers in the quarter to end with roughly 4.5 million subscribers.    MetroPCS added about 206,000 subscribers and ended with close to 6.3 million subscribers.  This would not be an overnight integration and would not come without cost and sacrifice.

It is hard to predict that a new offer will be brought back up just because both companies have been hit hard after earnings.  But this space is crowded and it is hard to imagine that the two independent players in the space can effectively compete against the giants in a price war.  Big telecoms will always win through time at that game.  Everything boils down to price.  If another offer was made in stock it would still allow shareholders to capture upside if and when the shares recover.

Leap and MetroPCS might want to reconsider a merger.  This could be need as the driving force rather than greed.

JON C. OGG
AUGUST 7, 2009