Why $80 billion for Sprint may make sense

Just a few years ago, a leveraged buyout of a company as big as Sprint Nextel (S) would have been unthinkable. The No. 3 wireless carrier has $41 billion in annual revenue and a market cap of $56 billion. Add in the cost of a 25% premium and the assumption of more than $23 billion in debt, and a Sprint Nextel buyout could be nearly twice as large as Texas Pacific's record $45 billion proposed buyout of power company TXU (TXU) (see BusinessWeek.com, 2/26/07, 'How Green Green-Lighted the TXU Deal').

Yet at least one investment bank is taking the idea seriously. Goldman Sachs (GS) issued a report to a group of its clients on Mar. 21 examining the economics of such a deal. The report, by Jason Armstrong and other analysts, concluded that 'the LBO economics are very favorable.'

Goldman Sachs' Analysis

The report was conceptual; it didn't suggest that negotiations with potential buyers were under way. 'But with the return profile better than many would expect, it's time to take an LBO scenario a bit more seriously and understand the return profile,' the report said. Goldman analysts weren't available to discuss the report. Sprint Nextel didn't respond to a request for comment.

Goldman said an LBO could have an internal rate of return of 30%. The IRR is a benchmark that takes the future value of a deal into account. Goldman assumes that a buyer would sell Sprint's noncore assets, hold the line on spending, and limit debt to 6.5 times earnings before interest, taxes, depreciation, and amortization (EBITDA).

The chance of such a deal actually happening anytime soon is low, given its size, Goldman said. It estimates a buyout would cost $86 billion, which would move it into record territory"”and then some. Goldman said it was unclear whether the debt markets would support such a transaction. Since the company is in the middle of a turnaround, it's not in shareholder interests to sell now and allow a future owner to reap a potential benefit, should there be one. And Goldman said a leveraged buyout might not leave enough cash to invest in the business. Sprint, which is having trouble holding onto customers, needs to make substantial investments in a number of areas (see BusinessWeek.com, 1/10/07, 'Sprint's Subscriber Woes Deepen').

Private Equity Revolution

That a deal of such magnitude is being given serious consideration reflects the evolution of the private equity business. Until last year, Kohlberg Kravis Roberts' $31 billion buyout of RJR Nabisco in 1988 seemed insurmountable. But over the past year, a number of ever-larger buyouts have been struck, including the $36 billion deal for Equity Office Properties and then the $45 billion TXU purchase.

Now, as private equity firms have raised multibillion-dollar funds, a deal of $50 billion or even $100 billion looks possible. In December, shares of Home Depot (HD) surged as traders speculated that the retailer could go private. Such a deal would have cost well in excess of $100 billion (see BusinessWeek.com, 12/1/06, 'Home Depot: A Big Orange Buyout‾').

Sprint has been the subject of takeover talks for years, although the most likely buyers have been considered telecom companies and cable TV operators. Sprint has struggled since its $35 billion acquisition of Nextel in 2004 (see BusinessWeek.com, 2/28/07, 'Sprint Nextel Rings Up Strong Profits').


Matt Michaelis, a vice-president with investment bank Jeff Williams & Co. in New York, said an LBO could make sense. 'Obviously, it would be quite large, but it could be an attractive candidate for someone to take private,' says Michaelis. If a buyer had a clear idea of how to fix the Sprint and Nextel integration issues, the prospects for a turnaround would be enticing. The company could support a lot of debt, which boosts the return of a buyout. And its wireless broadband spectrum could be an extremely valuable asset, if developed properly.

An Acquisition Scenario

One private equity expert said an LBO might be difficult to justify, though. Phillip Phan, a professor of management at the Lally School of Management & Technology at Rensselaer Polytechnic Institute, said the real value of the company is in its customers. An LBO would probably lead to sales of assets, which would limit subscriber growth. A strategic buyer such as Verizon (VZ) might make better use of the subscriber base and get more value from a deal.

Who would be in position to make such a bid‾ One possibility might be private equity giant Carlyle Group. The Washington-based firm is loaded with telecom veterans such as founder William Conway, a veteran of MCI. And Carlyle partner William Kennard, former chairman of the Federal Communications Commission, recently resigned from Sprint's board.

The talk of a buyout or acquisition stems from Sprint's weakened condition. It's having trouble with its business and financials, just as rivals' wireless data business is really taking off (see BusinessWeek.com, 1/23/07, 'Sprint Loses Its Wireless Data Crown'). If the company can't get a handle on its problems soon, it may not be in control of its own destiny too much longer.

Rosenbush is a senior writer for BusinessWeek.com in New York.

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