Home Business AT&T Bids for LEAP; Anti-Trust no Slam Dunk: JPMorgan

AT&T Bids for LEAP; Anti-Trust no Slam Dunk: JPMorgan

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AT&T Inc. (NYSE:T) is buying Leap Wireless International, Inc. (NASDAQ:LEAP) for $1.2 billion. Citigroup was the first firm out with a report on the late Friday afternoon news. They believe that AT&T could face a bidding war from DISH. About 10 reports are out from the big firms, most of them say similar things, but we highlight a few below. JPMorgan has some of the most insightful remarks on the potential buyout.

AT&T Bids for LEAP; Anti-Trust no Slam Dunk: JPMorgan

Philip Cusick, CFA of JPMorgan Asks

Could T-Mobile USA, Inc. (TMUS) or Sprint Nextel Corporation (NYSE:S) counterbid? Possible but unlikely given the price. Excluding the 700MHz license Leap Wireless International, Inc. (NASDAQ:LEAP) owns in Chicago, which we estimate is worth $206m, the transaction values Leap at $3.6b EV, 7.8x our 2013E EBITDA or 8.8x 2014.

We always believed T-Mobile USA, Inc. (TMUS) likely would want to own Leap eventually given the spectrum fit, but was in no rush, though the company recently bought spectrum from USM in a number of Leap’s Midwestern markets. While we don’t believe a full auction was run, we expect that the 100%+ premium to Friday’s price was at least in part to discourage other bidders and reduce the future risk of a stronger T-Mobile in those markets. However large the price though, the low termination fee of $46m if Leap accepts a superior offer leaves the door open.

Regulatory approval isn’t a slam dunk, but we think can be done. Since AT&T Inc. (NYSE:T) has only a small prepaid presence and Aio isn’t really off the ground, we believe AT&T likely can get approval of the deal by emphasizing its desire to keep the Cricket brand, dealers, and business model in Leap markets, and enhance the business with 4G and new markets.

If the transaction does not receive regulatory approval Leap has the option to enter into a 3-year LTE data roaming deal on AT&T’s network, which if exercised gives AT&T the option to acquire Leap’s spectrum in Chicago, Philadelphia, DC, Baltimore, NY, and WI. We believe it is possible that the FCC could require AT&T to divest some of the spectrum in markets like Philadelphia, Houston, San Diego, Las Vegas, Nashville, and New Orleans where it would exceed 120 MHz.

Simon Flannery of Morgan Stanley says

The deal is likely neutral for the Towers / Verizon Communications Inc. (NYSE:VZ) and negative for Sprint Nextel Corporation (NYSE:S) / T-Mobile USA, Inc. (TMUS) / US Cellular. We estimate that AT&T Inc. (NYSE:T) / Leap Wireless International, Inc. (NASDAQ:LEAP) would be a minimal impact for the Towers (PCS was ~1% of AMT / SBA revenues; Leap is ~3% of CCI). We see downside risk for most of the wireless carriers given their prepaid exposure and wireless saturation. In particular, Sprint and T-Mobile’s (branded) prepaid subscriber exposure is about one-third. T-Mobile’s plan to expand the MetroPCS Communications Inc (NYSE:PCS) brand into new markets could see headwinds.

Mike McCormack, CFA of Nomura says

As Leap Wireless International, Inc. (NASDAQ:LEAP) is one of the largest remaining operators, with spectrum covering two-thirds of the Top 100 markets, we would not be surprised if other parties come in with competing offers. Leap’s Cricket brand, network and distribution channels could provide a starting point for the likes of DISH, which is looking to enter the US wireless business. For existing operators, Leap’s spectrum and subscriber base could be complementary.

Valuation Accounts for Spectrum and Synergy Opportunities

We estimate the transaction values Leap Wireless International, Inc. (NASDAQ:LEAP) at 6.6x 2013 Adj. EV/EBITDA, in line with AT&T’s 6.7x Adj. EV/EBITDA, a premium for a wireless operator with declining subscribers and service revenue. The multiple falls to 5.2x EBITDA when including the value of Leap’s non operational MetroPCS Communications Inc (NYSE:PCS) and AWS spectrum licenses. Given spectrum scarcity, cost synergies, and growth from expanding the Cricket brand nationwide, we believe this multiple is rich but fair. AT&T intends to maintain and expand the Cricket brand distribution channels, adding it to its portfolio of prepaid brands. Please see our merger model on Page 2.

AT&T – -Further Building the Spectrum Portfolio

Pro forma for the transaction AT&T Inc. (NYSE:T) would have a weighted average position of ~125MHz in the Top 100 markets, higher than Verizon Communications Inc. (NYSE:VZ)’s but lower than Sprint Nextel Corporation (NYSE:S)’s when including Clearwire Corporation (NASDAQ:CLWR). Leap Wireless International, Inc. (NASDAQ:LEAP)’s MetroPCS Communications Inc (NYSE:PCS) and AWS spectrum is complementary to AT&T’s spectrum position, particularly as LTE is rolled out and demands wider channels.

This transaction could exceed the FCC David W. Barden, CFA of BAML says: AT&T’s acquisition of Leap Wireless International, Inc. (NASDAQ:LEAP) is small from a financial perspective ($1.2bn equity value and $3.9bn enterprise value), but has strategic sector implications as mid-tier carriers T-Mobile USA, Inc. (TMUS) and Sprint Nextel Corporation (NYSE:S) are battling better-financed competitors with stronger spectrum positions both above, and now below them as AT&T leans into the market.

We expect the Cricket brand will supplant AT&T Inc. (NYSE:T)’s nascent Aio pre-pay brand and accelerate its roll-out. AT&T expects the transaction to close in 6-9 months and noted that shareholders owning 29.8% of Leap’s outstanding shares have entered into an agreement to vote in favor of the transaction. Allowing LEAP holders to retain an interest in the 700MHz band spectrum should improve the deal’s regulatory chances.

If AT&T Inc. (NYSE:T) is unable to consummate the deal, it will owe Leap Wireless International, Inc. (NASDAQ:LEAP) a multi-year roaming deal and could be required to purchase certain spectrum.

Adding to spectrum war chest

AT&T’s acquisition of LEAP includes spectrum in the MetroPCS Communications Inc (NYSE:PCS) and AWS bands covering 137 million people. AT&T will have the industry’s 2nd largest average spectrum position (147MHz) across the top 100 markets following its acquisition of LEAP, behind Sprint Nextel Corporation (NYSE:S)/Clearwire Corporation (NASDAQ:CLWR), but ahead of Verizon Communications Inc. (NYSE:VZ) at 102MHz and T-Mobile USA, Inc. (TMUS) a distant 4th at 71MHz. AT&T plans to immediately deploy LEAPs unutilized spectrum covering 41m POPs to increase 4G capacity.

Incremental build good for towers

Putting Leap Wireless International, Inc. (NASDAQ:LEAP)’s underutilized and un-deployed spectrum in the hands of a willing and better-capitalized network spender like AT&T, greatly increases the likelihood of incremental network investment which is a positive for towers (AMT, CCI, and SBAC). Leap owns spectrum covering approximately 137m POPs with approximately 31% (42m covered POPs) owned outside its current operating markets. Additionally, within its operating markets, its spectrum utilization is only ~40% according to the company’s latest disclosures.

Goldman Sachs Opines:

Given Leap’s significantly smaller size relative to AT&T and technological differences (nearly 80% of POPs are still CDMA, vs. HSPA/LTE at AT&T), we believe near-term earnings accretion (neutral in year 1, with +2% FCF/share accretion by 2016) may have been less of a priority for AT&T Inc. (NYSE:T); instead, we believe there was likely a greater focus on spectrum needs, given Leap’s challenged market position but 23MHz of AWS/MetroPCS Communications Inc (NYSE:PCS) spectrum depth in its operating markets.

Regulatory implications / positive on potential sellers of spectrum

Relative to AT&T Inc. (NYSE:T)’s unsuccessful bid for T-Mobile USA, Inc. (TMUS), a couple things are worth mentioning: (1) the DOJ’s denial was focused on maintaining competition via four national operators, and did not regard Leap (or MetroPCS Communications Inc (NYSE:PCS) at the time) as effective competitors in its analysis, and (2) The FCC’s recent approval of Sprint Nextel Corporation (NYSE:S) and Clearwire Corporation (NASDAQ:CLWR) creates a much higher spectrum threshold in the industry.

We attribute very low value to Leap Wireless International, Inc. (NASDAQ:LEAP)’s customer base (high churn, low NPV/sub), and hence believe its spectrum holdings were critical to AT&T; the $4.0bn value would imply $1.37/MHz-POP for LEAP’s spectrum alone (if we assume no value for subs/NOL); we note 2/3rds of LEAP’s MHz- POPs are AWS band, where recent deals have been at a range of $0.55- $0.96/MHz-POP. Given spectrum scarcity, we believe TMUS (Buy) and DISH  carry strategic value to potential acquirers via their spectrum.

Industry takeaways: mixed for S/TMUS, positive on Towers

AT&T Inc. (NYSE:T)’s potential expansion of the Cricket brand could present greater prepaid competition for Sprint Nextel Corporation (NYSE:S)/ T-Mobile USA, Inc. (TMUS). Expansion of LTE and greater capex in Leap Wireless International, Inc. (NASDAQ:LEAP)’s markets is an incremental positive for the Towers.

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