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Spectre of blocked Sprint/T-Mobile merger spooks SoftBank

Failure to pull off deal would add extra pressure on group

Some analysts believe that Sprint, in which Softbank has an 85% stake, may be unable to survive if its planned merger with T-Mobile is blocked in a trial that ends this week. (Nikkei Montage)

TOKYO -- In the midst of an avalanche of bad news about layoffs at the startups that it backs, SoftBank Group is hoping for a rare boost of confidence: regulatory approval for its U.S. telecoms carrier Sprint to merge with rival T-Mobile. But SoftBank may not get it.

In August, SoftBank CEO Masayoshi Son said the $26 billion merger had "taken longer than expected" but had made "significant progress" after receiving conditional approval from the U.S. Department of Justice. "From day one ... the basic strategy has been to integrate Sprint and T-Mobile" and bring a fight to the top two U.S. carriers, Verizon and AT&T, he said.

Instead, however, a lawsuit launched by a group of U.S. states has thrown what once appeared a done deal into uncertainty. Some investors and analysts even caution that Sprint, in which SoftBank has an 84% stake, may be unable to survive if the merger does not go ahead. At the very least, Sprint will require a capital injection to keep going.

"If the deal is killed, we believe a restructuring of some sort, such as a bankruptcy filing or highly dilutive equity infusion, is well within the realm of possibilities," Michael Hodel, director of Morningstar, a research boutique, wrote in a recent note to clients.

As one marker of the merger's growing uncertainty, Sprint's stock price has dropped by 12% since the trial started in December. By contrast, T-Mobile has gained by 2% over the same period.

The states, including New York and California, claim the merger will reduce competition and hurt consumers. The trial, which ends on Wednesday with a final ruling due in February, has centered around whether Sprint's sale of some assets to U.S. satellite TV provider Dish Network -- a side deal that led to the merger's federal approval -- is enough to form a viable fourth competitor in the U.S. telecoms market.

If the trial deems that is not the case, the deal would be blocked. That would generate more bad news for SoftBank's shareholders, and further uncertainty about Son's strategy.

Since unveiling the Vision Fund over three years ago, Son has been busy transforming SoftBank from a telecoms group to an investment company focused on tech startups and artificial intelligence.

However, Sprint remains valuable for SoftBank because it is among a handful of large assets, along with Alibaba and the Japanese mobile operator SoftBank Corp, that are publicly traded. As such, they can be more easily sold than the mostly unlisted assets in the Vision Fund.

Indeed, the Vision Fund's strategy to generate cash by listing investments has been dented lately by U.S. office sharing company WeWork's canceled initial public offering, the subsequent write-down in its valuation and SoftBank's decision to pump $9.5 billion into the company to keep it going.

A blocked Sprint/T-Mobile merger, and any subsequent injection of capital into Sprint to keep the company afloat or to make it appealing for potential buyers, would draw unflattering comparisons to the rescue package SoftBank pumped into WeWork last year.

The bull case for SoftBank, on the other hand, is approval of the Sprint merger. Its combination with T-Mobile would create a larger third U.S. carrier that can invest in the fifth-generation wireless network.

Expected synergies and savings, such as in network operating costs, could push up the equity value of the combined company to $101 billion, $13 billion more than what the two companies were together worth at the end of last year, estimates Chris Lane of Sanford C. Bernstein.

"This is the biggest near-term potential catalyst for the Group," he wrote in a recent report.

In addition to narrowing SoftBank's so-called "conglomerate discount" -- the over $100 billion difference between the value of the assets on SoftBank's balance and its market capitalization -- the merger will broaden SoftBank's financing options as it makes additional investments in the future, such as its tech holdings, says Motoki Yanase, analyst at credit rating agency Moody's.

That is because SoftBank measures its financial health on a metric called loan-to-value, or net debt as a percentage of the value of its investments. A higher value for the combined Sprint/T-Mobile company would help lower that ratio, which SoftBank said was 17% as of September and wants to keep under 25%.

A lower ratio, in turn, will reduce any pressure on SoftBank to sell assets quickly or to invest less aggressively in its other companies or other projects -- such as Indonesia's new capital.

SoftBank could eventually sell on what will be its 27% stake in the combined company under the terms of the merger. It may also be able to pledge the shares as collateral to take out loans. SoftBank has used a similar scheme to raise some $9 billion in margin loans, backed by its 26% stake in Alibaba.

On the other hand, a collapse of the merger would be a major setback. Sprint is saddled with some $40 billion in debt, is loss-making, and remains a distant fourth player in the U.S. telecoms market.

"It's increasingly questionable whether Sprint has any equity value as a stand-alone company," said Walter Piecyk, an analyst at LightShed Partners.

Son has pledged since the WeWork bailout not to make any more "rescue investments," although a back-of-the-envelope calculation suggests that to bring Sprint's financials in line with its U.S. peers could require several billions of dollars.

Sprint's almost $40 billion of debt, for example, is three times the company's earnings before interest, taxes, depreciation and amortization, otherwise known as ebitda. By comparison, at less-leveraged Verizon, debt is just 2.2 times its ebita, while it is 2.6 times at AT&T.

Shinji Moriyuki at SBI Securities said Sprint will likely make a "rational decision" to survive independently by leasing out or selling its spectrum. But how quickly or at what price it can find buyers is uncertain. SoftBank has not laid out an alternative plan in case the merger collapses.

SoftBank paid $21.6 billion for Sprint in 2013, underlining Son's ambitions to take on the U.S. telecommunications market. The deal came on the heels of its 2006 acquisition of Vodafone's Japanese unit, now SoftBank Corp, which pays billions of dollars in dividends and raised nearly $20 billion in an IPO in December 2018.

Sprint's turnaround attempt has been less successful. Despite an aggressive pricing strategy, it lost ground to T-Mobile. SoftBank's 84% stake is worth around $17 billion today -- over $4 billion less than SoftBank paid for it.

The uncertainty surrounding the merger comes at a time when various startups backed by the Vision Fund have laid off employees in a quest for profitability.

Indian hotel startup Oyo has laid off over a thousand employees around the world. Zume, an automated pizza delivery company, and Getaround, a car rental platform, are among the other startups that have announced layoffs.

Such moves indicate that turmoil has spread beyond WeWork, raising questions around Son's strategy of investing large amounts of capital in late-stage startups. The Vision Fund portfolio also includes some of the world's most highly valued tech companies, including China's ByteDance and Didi Chuxing.

SoftBank's own stock price has risen nearly 20% since the Sprint/T-Mobile trial began in early December, but that is mostly thanks to an around 15% surge in Alibaba's share price.

If the Sprint and T-Mobile merger is blocked, the focus will likely turn to whether some of SoftBank's Alibaba holding, which is worth around $160 billion, may need to be sold.

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