What Sprint Sees in Virgin Mobile USA

Sprint Nextel Corp. (S) made a surprise move July 28 when it said it will buy prepaid mobile services provider Virgin Mobile USA (VM), the MVNO in which Sprint already owns a 13.1 percent stake.

Sprint has agreed to pay $483 million, or $5.50 per share, in an all-stock deal. The price is 31 percent higher than Virgin Mobile’s July 27 stock close of $4.21. And if the deal collapses, Sprint has ensured it won’t be badly burned: If Virgin Mobile accepts a superior offer or otherwise backs out of the merger, it will fork over a $14.2 million cancellation fee. Otherwise, Sprint will take on all of Virgin Mobile USA and retire up to $205 million of its new subsidiary’s debt.

A Fresh Move for Sprint

Sprint has suffered notorious customer service, integration and cultural problems since acquiring Nextel in 2005. As a result, thousands of valuable postpaid subscribers continue to leave Sprint for AT&T Inc. (T) and Verizon Communications Inc. (VZ) each quarter. Focusing on the prepaid segment should help Sprint compensate for its troubles, especially as the never-ending recession forces people to economize in new ways.

Indeed, more and more wireless users are turning to prepaid service plans for just that reason and the growth in that niche only looks to increase. In fact, research firm ATLANTIC-ACM projects the prepaid market in the United States to grow by a compound annual growth rate of 3.9 percent through 2014, with a combined Sprint – operator of the Boost Mobile brand – and Virgin Mobile controlling 17 percent of that market.

Of course, it doesn’t hurt that Virgin Mobile USA already provisions its wireless plans over Sprint’s network. That means integration hiccups should be few and far between, at least on the network side. If they play their cards right, Sprint and Virgin Mobile will join forces to compete soundly against low-cost rivals Leap Wireless (LEAP) and MetroPCS (PCS). In terms of numbers alone, that appears doable. Sprint already boasts 49 million wireless customers; Virgin Mobile will add more than 5 million. Leap Wireless and MetroPCS, on the other hand, have fewer customers – Leap Wireless ended the first quarter with 4.3 million users, while MetroPCS reported 6.1 million.

It’s no stretch to say Sprint has the advantage – and intends to capitalize on it.

“Prepaid is growing at an unprecedented rate with consumers keenly focused on value,” said Sprint CEO Dan Hesse in a prepared statement. “Virgin Mobile is an iconic brand in the marketplace that will complement our Boost Mobile brand.”

Still, Sprint will have to convince the masses that its customer service has improved. That aspect of the company has deteriorated to the point Sprint consistently has made the MSN Customer Service Hall of Shame. Sprint’s been working to reverse the trend, however, through a combination of soothing TV ads and innovative pricing plans.

What’s Next for Sprint, Virgin Mobile

But first things first. Sprint expects to close the transaction in the fourth quarter of this year or early in 2010, with Virgin Mobile CEO Daniel Schulman at the helm of the prepaid business. Pending changes include “synergies to be derived from general and administrative reductions, operational efficiencies, and streamlined distribution,” Sprint said in a press release. In other words, there will be job losses and other cuts.

There’s also the small matter of regulatory approvals. With more consolidation skeptics steering the federal government now, one might expect intense scrutiny of proposed transactions such as Sprint’s and Virgin Mobile’s. But telecom analysts at investment bank Stifel Nicolaus don’t think that will be the case.

“Because Virgin Mobile USA and its recent acquisition Helio are both MVNOs … we do not see the deal raising serious antitrust issues, and thus believe that DoJ will approve the deal,” Rebecca Arbogast and David Kaut wrote in a July 28 memo to clients.

The MVNO distinction is important. Resellers tend not to hold wireless licenses, which means the FCC has no jurisdiction over them. The caveat here is that Virgin Mobile does have “a small number” of international licenses that would need to be transferred, Arbogast and Kaut said. Because of that, the FCC will be part of the merger reviews, but “we think it unlikely that the agency review would pose material obstacles,” the analysts said.

Arbogast and Kaut cited the approvals of the Verizon-Alltel and Sprint-Clearwire transactions as proof. In each of those orders, they noted, “the FCC reaffirmed its view that it excludes MVNOs and resellers from its analysis of the competitive impact of a wireless merger.”