DOJ Reviews Softbank and Sprint Nextel Merger [ANALYSIS]

DOJ and FBI, backed by the Department of Homeland Security, have asked the FCC to not act on the proposed takeover of Sprint (S) by Japan’s SoftBank until the agencies complete their review of related national security, law enforcement, and public safety issues.

Analysts at Stifel Nicholas expect the FCC to agree, as it has done in the past when the DOJ and other agencies have made similar requests on proposed foreign purchases of U.S. companies/stakes. The analysts assume that the agencies will be particularly interested in resolving any potential concerns about SoftBank’s relationship with Chinese equipment makers Huawei and ZTE. Stifel believes that they could impose equipment restrictions and/or review processes, though they don’t expect them to block SoftBank’s purchase of 70% of Sprint outright.

The DOJ filed the request in a letter to the FCC, which is reviewing both the SoftBank-Sprint deal and Sprint’s proposed takeover of 100% of Clearwire Corporation (NASDAQ:CLWR). Petitions to deny associated license transfers were due yesterday. Dish (DISH) said it wasn’t making a filing at this time “due, among other things, to the uncertainty surrounding the ownership of Clearwire and Dish’s continued negotiations” with Clearwire board members “to acquire the company or certain assets of the company.” Dish said it intends to participate in reply comments due on Feb. 25 (opposition to petitions to deny is due on Feb. 12).

Dish previously asked the FCC to put its review of the SoftBank/Sprint/Clearwire transactions on hold due to the uncertainty, but many sense was that the FCC was unlikely to suspend the review absent further developments. The DOJ/FBI/DHS request adds another wrinkle to the equation. However, while Stifel wouldn’t expect the FCC to conclude its review prior to the other agencies resolving any concerns, investors are not sure it would put the proceeding on hold, unless there’s some sort of indication that Clearwire’s board is at least seriously pursuing a deal with Dish, which would face difficulties related to Sprint’s majority ownership, influence, and contract rights with Clearwire.

Verizon Wireless (VZ-VOD) didn’t oppose the transactions, but filed comments urging the FCC to revise its spectrum screen to include virtually all of Clearwire’s 2.5 GHz band spectrum, which averages 160 MHz in the top 100 markets. Verizon noted that the FCC’s screen only counts 55 of 76 MHz of “BRS” spectrum, and none of the 118 MHz of “EBS” spectrum. Verizon said both should be included in the screen because they were “suitable and available” for mobile telephony/broadband services (the FCC criterion). At some point, many suspect the FCC will agree at least in part, but Stifel believes that it’s reluctant to resolve this issue outside of its separate rulemaking on spectrum aggregation. Still, the Verizon Communications Inc. (NYSE:VZ) push could help prod FCC decision making. Even if Clearwire doesn’t have to divest the spectrum, counting more of it in the screen would give Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (NYSE:AT&T) more headroom to add spectrum.

Analysts at Morgan Stanley have a report out today, in which they pose an interesting question:

With Clearwire’s stock now trading above the Sprint ($2.97) and DISH ($3.30) bids, the market appears to be assuming that Sprint raises its bid at least 13% and likely much more given the downside risks.

A look at the Timeline

12/17/12 – Sprint enters into a definitive agreement with Clearwire to buy the outstanding shares it does not already own for $2.97 per share. Comcast, Intel and BrightHouse committed to vote their shares (~13% of total voting shares) in support of the transaction. Softbank and Sprint Nextel Corporation (NYSE:S) also entered into an additional financing agreement for up to $800m. The deal was expected to close in mid-2013, likely in conjunction with the Sprint / Softbank deal.

1/8/13 – Clearwire discloses that it has received an unsolicited non-binding proposal from DISH, which includes an offer to buy up to all of Clearwire’s common stock for $3.30 per share (subject to minimum ownership of at least 25% and granting of certain governance rights). DISH also proposed spectrum purchases, a commercial agreement and financing provisions.

Likely (according to Morgan Stanley)

1) Sprint raises its bid above current trading levels to ensure a successful vote (x% upside) – Sprint will likely be reluctant to raise its bid above what it sees as an “illusory” offer, although it is likely keen to resolve the uncertainty. Even if Sprint raised its bid to around $3.30, it is possible that DISH could counter with a higher bid, creating a bidding war.

2) Sprint matches DISH’s $3.30 offer and wins approval (2% downside) – In order to ensure victory, Sprint raises its offer to $3.30 and is successful in winning the Clearwire shareholder vote.

3) Sprint raises its bid to $3.15 and wins approval (6% downside) – Sprint raises its bid modestly, but does not match the DISH offer, but nevertheless, Sprint is successful in winning the Clearwire shareholder vote. Analysts at Morgan Stanley think this may be the most likely scenario.

Key Questions

What will the Clearwire Special Committee do? Clearwire has said that a special committee of the board of directors will “engage with DISH to discuss, negotiate and or provide information in connection with the DISH proposal.” This process may take several weeks, but many anticipate that an update should be provided over the next month or so. There are several elements to the transaction, including the $3.30 offer, a spectrum purchase proposal, financing and a proposed commercial agreement. Note that prior to the Sprint /Clearwire deal, DISH had presented another proposal including a spectrum purchase and commercial agreement. Clearwire Corporation (BASDAQ:CLWR) is able to dispose of “excess” spectrum without Sprint’s approval / veto right, although Sprint would have a right to bid on the spectrum being sold.

Will Sprint Raise / Match Their Bid?

Sprint provided Clearwire with its view of the DISH proposal, noting that “it is illusory, inferior to the Sprint transaction and not viable because it cannot be implemented in light of Clearwire’s current legal and contractual obligations.” This would suggest that Sprint does not feel the need to raise its bid, although it would likely increase the risk that it fails to garner support from ~50% of the non-Sprint shareholders if it continues with a $2.97 offer. Much depends on Softbank’s priorities and price sensitivity.

In any event, with a vote probably three or four months away, Sprint does not need to move immediately, although as Clearwire is not drawing on the $800m facility, the TDD buildout may be slower than desired this year. Matching the bid would cost Sprint another $250m or so.

Can Sprint and DISH Reach an Accommodation?

Some believe that DISH’s actions are part of a strategy to reach an agreement with Sprint around network sharing or the sale of some of Clearwire’s spectrum to DISH. It is certainly possible that a deal can be reached, but right now, it appears that there are substantial disagreements between the companies as evidenced by DISH’s proposal and Sprint’s response. Sprint’s board has strict limits on what it can do independently of Softbank under their merger agreement, so negotiations would be extremely complex.

When is the Shareholder Vote?

The companies expect the Sprint / Softbank and Sprint / Clearwire transactions to close mid-2013. The Clearwire deal is contingent on the Softbank deal closing. At this point, the shareholder votes are not the gating item; rather, it is regulatory approval, particularly the CFIUS or foreign ownership review process. Assuming no change to the board’s recommendation, expect a vote in April or May.

Litigation / Regulation?

There have been a number of lawsuits and regulatory filings directed at both the Sprint / Clearwire and Sprint / Softbank transactions. DISH recently asked the FCC to stop the “shot clock” in its review of the Sprint Softbank transaction, which is expected to close mid-year. This follows disagreements between Sprint and DISH last year over spectrum interference issues arising from the DISH spectrum approval process in front of the FCC.

How Badly Does Sprint want to own all of Clearwire?

Sprint has maintained an approximate stake of 50% in Clearwire since it merged its WiMAX operations into Clearwire back in 2008. Just two months after the Sprint / Softbank deal was announced, Sprint agreed to buy control of Clearwire. This suggests that Clearwire was an important element of the Softbank strategy for Sprint, while Softbank’s capital injection would finally give Sprint the resources to absorb the leverage and dilution from Clearwire. The quick bid could also have been driven by DISH Network Corp. (NASDAQ:DISH)’s earlier proposals to Clearwire for spectrum sales and a commercial agreement. Softbank Corp (TYO:9984) is likely attracted to Clearwire’s abundant spectrum holdings (making a deal to sell spectrum to DISH unattractive), as well as the compatibility of the 2.5 GHz band and TD-LTE deployment plans with Softbank’s Japanese strategy.

The fact that Sprint also agreed to provide financing to Clearwire (currently on hold) to accelerate the TD-LTE rollout, also suggests that Sprint / Softbank believe in moving quickly. Currently, Sprint only has 10 MHz of G block spectrum available for LTE, and Verizon and AT&T (and T-Mobile to some extent) are moving rapidly to build out their footprints. On the other hand, there is not much availability of TD-LTE devices right now limiting the impact of any 2013 deployment.

What is Clearwire Worth?

Valuing Clearwire is a challenging exercise given its unique spectrum position, substantial debt, and spectrum lease commitments and FCC / DoJ constraints on spectrum aggregation. Looking at other spectrum transactions as comps is not that helpful.Analysts doubt that AT&T, Verizon or T-Mobile have significant interest at this point for a variety of reasons.

Conclusion

In the end, Clearwire is worth what someone (Sprint / Softbank and perhaps DISH) will pay for it. Thus, it is the result of negotiations between Sprint Nextel Corporation (NYSE:S), Softbank Corp (TYO:9984), Clearwire Corporation (NASDAQ:CLWR), and DISH Network Corp. (NASDAQ:DISH), with the input of various shareholders and advisors. It will be interesting to read the valuation discussion in the Clearwire’s proxy which will show how, in December, Clearwire’s board concluded that $2.97 was a fair value for the deal.

Disclosure: No position