Sprint and T Mobile’s Extreme Debt Post-Merger

During the financial crisis, the price of Sprint stock fell from $24 per share to $1.30, effectively pricing into the stock the looming possibility of bankruptcy. At the time, Sprint had a debt burden of $20 billion and was losing $1.6 billion during calendar year 2008.

I never write about Sprint as an investment because the debt burden has been just too speculative—if I can’t be reasonably sure that the debt won’t force the company into bankruptcy within the next decade or so, why cover the business enterprise?

With interest rates still so low, it can be easy to forget that debt obligations matter. Then, you peek out and see news items today like Gibson Brands, Inc.’s news of bankruptcy. The maker of Gibson Guitars is “profitable” in the sense that that the core businesses generate revenue that is greater than its non-debt related expenses, but it is not profitable once the debt payments resulting from its $135 million acquisition of Koninkliike Phillips NV are taken into account. My view is that the low interest rates of the past few years may have lulled investors into tolerating debt-related risks because nothing catastrophic has seemed to occur in the context of large-cap publicly traded stocks in the United States in recent memory.

On the short list of companies that could find itself bankrupt in the next generation is the combined T Mobile and Sprint entity. The colossal balance sheet debt of the combined firm is almost unimaginable to comprened—T Mobile has $30 billion in debt and Sprint has $36 billion in debt. Compared, they would be a company earning $3 billion in profits that carries $66 billion in debt. Approximately $25 billion of that load would need to be paid within the next five years—i.e. more likely, refinanced at an even higher interest rate.

Also, beginning in 2019, all of the off-balance sheet leases to operate cellphone wireless towers will need to be reclassified as debt. For T Mobile, this amounts to $2.4 billion in additional debt accumulation that will be formally classified as such, for a total of $18 billion, and for Sprint, the total is an additional $2.1 billion in annual obligations that total $17 billion.

So a true approximation of the debt obligations would be $101 billion in debt, with $35 billion due within the next five years.

It is also a moot point, but T Mobile has 20 million shares of convertible preferred stock paying out 5.5% which could add a bit of shareholder dilution to the mix as well.

I don’t how anyone in good-faith could make a long-term buy and hold investment in this combined enterprise. T Mobile, which was unprofitable as recently as 2014, is slated to earn a record-shattering $2.8 billion in profit this year. Sprint has had four year in the past decade in which it sustained losses higher than that, with the $4.3 billion loss in 2012 being the most extreme.

I have little interest in seeing what happens if a business with $101 billion in obligations to various creditors has a year in which it loses $1.2 billion (which a “bad year” from the Sprint assets could make happen).

Analysts are discussing what a great fit it will be to mix the mid-band and high-band spectrum capabilities of Sprint with the rights to low-band 600 MHz spectrum that T Mobile recently purchased, which could theoretically build its network to better rival Verizon and AT&T.

If this combined company was earning $3 billion with a cumulative debt burden in the $25 billion range, that would be an intriguing conversation to have. But that that is not the case. The combined entity will have formally have $60+ billion in debt from its inception which will formally be recognized for the $100+ billion debt that it is when the new 2019 accounting rules take effect.

On a side note, this reminds me of a lesson from the Janet Weiss book “Dividends Don’t Lie” when she explained the title of her book by pointing out that companies with balance sheet issues can’t pay dividends because the terms of their debt obligations with their lenders won’t allow it. In this regard, it is telling that the two companies, which combined transact for $77 billion in total business each year, do not pay a dividend at all.

The old Chinese proverb says “Only in winter do the pine and cypress show they are evergreen.” With rising stock prices in recent years, many junk-y businesses with poor balance sheets have been justified as  all-weather, blue-chip investments. The prudent investor should summarily discard investing in the T Mobile – Sprint combined firm, as the enormous debt burden portends shareholder pain within the next generation.

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