Dish Rally on Sprint Deal: We Dish the Dirt

David J. Phillips
April 19, 2013

DISH Network's (DISH) unsolicited $25.5 billion bid for Sprint Nextel (NYSE:S) would create an attractive combination of assets, spectrum bandwidth, and bundled service offerings that could better position the combined entity to rebuff strong competition from market leaders AT&T (NYSE:T) and Verizon (VZ). However, the major U.S. credit rating agencies have raised cogent concerns that the cost of the proposed deal combined with execution delays in integrating the operations of the wireless carrier could bust the financial health of the U.S. pay-per-view provider. The Dish and Sprint market caps are dwarfed by the competition.

DISH Market Cap Chart
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DISH Market Cap Chart

DISH Network Chairman Charles Ergen pointed out on the (proposed) merger conference call with analysts that increasing customer demand for video content – projected to grow to 80% to 90% of all data usage on tablets and mobile phones – is the big reason the “data pipes are getting clogged.” He convincingly argued that the combined company would be strategically positioned to provide more reliable network connectivity across multiple platforms, as DISH brings 45 megahertz of unencumbered spectrum – bandwidth that would cost Sprint up to $12 billion to build in the open market, according to Ergen.

This deal offers multiple venues for revenue growth, too. DISH could offer subscribers triple-play services (high-speed internet, phone, and video) by merging its own satellite network with Sprint’s wireless network. In terms of cross-selling – excluding overlap – there is the equivalent of 17 million Sprint households that could be targeted for DISH Pay-TV services and approximately 14 million current DISH households that could potentially add about 35 million new mobile users to Sprint’s subscriber base.

Management opines that potential revenue and cost synergies could reach $37 billion, of which $11 billion would come from the spend side (alignment of sales & distribution channels and reduction of similar operations, such as call centers or billing and collections services).

Fitch Credit believes, however, that the deal is fraught with substantial execution and integration risks. In addition to the uncertainties that exist when merging distinct corporate cultures, delivering on envisioned bundled services would require a significant build-out of the number of cell sites to increase network capacity -- in both rural and high-density, urban areas – to meet the anticipated increase in new demand. Such an infrastructure investment program would take much longer than the 24 to 36 month forecast outlined on the conference call by DISH management.

The $25.5 billion bid is a cash and stock deal: $17.3 billion of cash and $8.2 billion of DISH common stock. The deal would be dilutive to DISH shareholders, as Sprint owners would receive $4.76 in cash and 0.05953 DISH shares per Sprint share.

Capital-intensive build-out combined with fighting content and subscriber wars over the years against the likes of Comcast (CMCSA) and DirecTV (DTV) has produced inconsistent earnings’ performance and an exhausted balance sheet.

DISH EBITDA Margin TTM Chart
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DISH EBITDA Margin TTM Chart

Although DISH generated free cash flow of $1.03 billion last year (down from $1.67 billion in 2011), the deal would require the company to raise an additional $9.3 billion of debt financing to fund the merger with Sprint.

Sprint might hold value for its wireless assets, but what DISH management didn’t talk about on its conference call was the anemic condition of the third-largest U.S. carrier’s balance sheet. Going it alone to upgrade its network to the 4G standard has proved costly: As of December 31, 2012, Sprint’s total debt was approximately $24.3 billion! In addition, earnings were inadequate to cover fixed charges by $3.3 billion last year, up from a shortfall of $1.3 billion in 2011.

Like Sprint, DISH’s debt is “junk-rated.” Nonetheless, that hasn’t stopped both Moody’s and Standard & Poor from placing DISH’s corporate debt on credit watch for a possible further downgrade below its current speculative rating of ‘BB-‘.

Citing additional debt that DISH would assume post-merger, S&P credit analyst Michael Altberg forecasts total indebtedness to trailing 12-month EBITDA (adjusted leverage) of the combined entity to be in the high 6 to low 7 times in 2013, declining to about 6.5 times in 2014. However, Altberg’s forward guidance is modeled on EBITDA improvements premised on previously mentioned synergistic benefits – which is a big IF—and also doesn’t include increasing infrastructure spending needs.

Albeit the proposed merger would visibly improve the scale and scope of DISH’S domestic wireless and pay-per-view offerings and growth prospects, unrelenting competitive pressures will likely continue to pressure financial prospects. Investors looking for value in cable telephony could be better off owning the likes of better capitalized and more attractively valued (P/Cash Flow) companies like Verizon or AT&T.

DISH Price to Cash Flow TTM Chart
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DISH Price to Cash Flow TTM Chart

David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive. He can be reached at editor@ycharts.com.


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