Nextel and Sprint: The Big Little Guy

By Steve Rosenbush Faced with growing pressure to upgrade their networks and compete with larger rivals, Sprint (FON) and Nextel Communications (NXTL) have joined forces in a $35 billion takeover that will give the combined entity a value of around $70 billion.

The outlines of the agreement, announced on Wednesday, Dec. 15, were reached earlier in the week. Sprint CEO Gary Forsee, a one-time BellSouth (BLS) executive, was named CEO of the merged company, to be known as Sprint Nextel. Nextel CEO Tim Donahue was named executive chairman. The new combo would be based at Nextel headquarters in Reston, Va., although it would maintain its operating headquarters at Sprint offices in Overland Park, Kansas. The deal is likely to receive approval from regulators and close during the second half of 2005.

Under the terms of the deal, Sprint will exchange 1.3 of its shares for every share of Nextel. Sprint also will contribute a small, yet-to-be-determined amount of cash, so that it will own more than 50% of the new company. This is necessary to preserve the tax-free spin-off of Sprint's local phone lines, which can't happen unless one of the companies survives as a continuing corporate entity.

PLAYING CATCH-UP. Telecom giant Verizon Communications (VZ) considered making a run at Sprint itself, according to one banker familiar with the matter. Verizon and Vodafone (VOD), the British wireless giant that owns 45% of Verizon Wireless, spent the weekend of Dec. 11-12 trying to hash out an agreement on how to proceed, the banker says. Verizon couldn't go forward with a bid for Sprint without Vodafone's approval.

Now, Verizon appears to have decided it's a no-go with a Sprint bid -- at least for now. It could still step into the fray at some point in the future, but a breakup fee could boost the price of a future bid by 3% to 5%. That wouldn't necessarily be prohibitive.

Donahue and Forsee made big, bold promises about the future of the new company. "In short, we are creating the premium communications company in America," Donahue said during a press conference in New York. "I am thrilled to be part of this historic event."

SOLID RECORD. And he left little doubt about who sits atop the organizational chart. Donahue spoke first and at great length. And while he lavished praise on Forsee, it was Donahue who came across as the dominant figure. After successful stints at MCI and Nextel, he's considered one of the leading operating executives in the industry. It's telling, perhaps, that Forsee's job as CEO is considered part of an "office of the chairman."

Considering his track record, Donahue has the right to make bold claims. And they shouldn't be dismissed out of hand. After two or three years, it's possible that Sprint Nextel really will become America's dominant telecom. He has breathed new life into Nextel, which was considered doomed to failure just three or four years ago.

But it's hard to overestimate the difficulty Donahue will face making good on his promise. For now, Nextel and Sprint shouldn't be all that threatening to No. 1 Verizon or Cingular, the wireless giant owned by SBC Communications (SBC) and BellSouth. Sprint and Nextel are two midsize players rushing to catch up with their bigger rivals (see BW Online, 12/13/04, "The Logic Behind a Sprint-Nextel Deal").

DOUBLE THE SPECTRUM. The deal will put competitive pressure on national carrier T-Mobile, which is owned by German telecom giant Deutsche Telekom (DT), and on smaller, independent regional players. And the combined telecom would be a more potent rival than either Nextel or Sprint is alone. The merger could force Verizon and Cingular to continually reevaluate their positions in a changed competitive landscape.

But the deal isn't an industry-transforming event -- and hardly reason for panic among the giants. Verizon and Cingular aren't desperate for spectrum space. As their needs grow, they'll have plenty of opportunity to buy more bandwidth in federal auctions, which are set to begin in January and continue over the next two years. The sales will double the amount of spectrum on the market, and prices aren't expected to soar the way they did during the auctions of the 1990s.

The biggest winner in the deal is Nextel. Its management has done a great job of competing, but now it needs to upgrade its network so it can offer higher-speed mobile Internet access and services. It has tested so-called 4G (fourth generation) wireless technology made by Flarion, but a systemwide upgrade would cost up to $10 billion, one investment banker says.

POSSIBLE LOSERS. It's far cheaper for Nextel to merge with Sprint and adopt its partner's CDMA (code division multiple access) wireless technology. That upgrade would cost only $2 billion to $3 billion. The companies will operate separate networks and brands for about two years, until the next generation of CDMA technology is available.

The big losers appear to be Flarion and Motorola (MOT), which has been Nextel's key supplier of the trademark mobile handsets that include the popular walkie-talkie-like feature. But Donahue promised that Motorola will be a key supplier for the new company.

With 32 million core subscribers -- 38 million if Sprint's wholesale business and its regional affiliates are included -- Sprint Nextel will be a distant No. 3 among wireless outfits. Verizon has 42 million subscribers, and Cingular 47 million. And these giants are hardly sleepy or slow-moving. Cingular has been doing a solid job of integrating its acquisition of AT&T Wireless and getting new handsets to market.

FAST GROWER. Verizon Wireless remains one of the most successful enterprises in the world. It's still adding 1.7 million subscribers per quarter, which means it could reclaim its No. 1 status from Cingular, even without an acquisition.

If it were a stand-alone company, Verizon Wireless, with $3.5 billion in net profit in 2004, would be comparable in growth to the likes of Cisco (CSCO), Intel (INTC), and Dell (DELL). An analysis by investment bank Evercore shows that Verizon Wireless achieved a compound annual growth rate of 30.6% from 1999 to 2003, beating Cisco, Intel, Dell, and Microsoft (MSFT). Evercore expects Verizon Wireless to grow 14.2% from 2003 to 2006, beating Cisco, Intel, and Microsoft but trailing Dell by about 1.5 percentage points.

It will take Nextel and Sprint several years to reap the full benefits of their merger. It wouldn't be surprising if conflicts in the new office of the chairman erupted, either. As a general rule, power-sharing arrangements are difficult to make work.

WELL-POSITIONED. Both companies have strong management teams, however. Sprint has done well in the wholesale wireless business. And by offering a unique walkie-talkie service, Nextel has carved out a profitable niche. And it has maintained its edge, even as rivals have tried to copy the technology.

If Nextel can retain its strong executive team and make a transition to a more advanced network, it should become a powerful rival during the next few years. It's well positioned in wireless, which is expected to be the engine of telecom growth for decades to come. Sprint Nextel may not emerge as the industry's clear leader, but it should have enough scale and technological and marketing prowess to succeed. With Emily Thornton in New York

Rosenbush is a senior writer for BusinessWeek Online in New York

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