Few things get the market's juices flowing quite like the prospect of industry consolidation. Just look at Sprint Nextel (NYSE:S) and Level 3 Communications (Nasdaq:LVLT). Word has it that these two telecom players are in talks to merge into a joint venture and possibly spin-off their long-distance network businesses.

IN PICTURES: Eight Ways To Survive A Market Downturn

Level 3 stock closed up about 30% last week, while Sprint was up 3.5%. The deal sounds appealing, to be sure. But before rushing out and buying more shares in the two stocks, it's worth looking at it more closely.

Long-Distance Losses
In light of the hard times in the long-distance field, it might be opportune for the companies to push the two units together. Thanks to the recession, spending on long-distance calls has fallen off a cliff, and who knows when things will turn around.

At the same time, a flurry of M&A activity has shrunk the number of local telephone companies that buy wholesale long distance, putting pressure on pricing and margins. The hope is that together Sprint and Level 3 could unearth some synergies and squeeze more cash out of each mile of their networks.

Debt, Debt, Debt
As exciting as the idea of cobbling together those long distance networks may be, it doesn't solve a bigger problem - the companies' levered balance sheets. Sure, Sprint has about $4.5 billion in cash and marketable securities, but it's also has about $21.6 billion in debt to worry about.

With a reported $800 million in free cash flow for the quarter from its wireless business, it ought to be able to produce just enough cash to cover its debt payments. Level 3, on the other hand, has dug itself into a debt hole of $6.4 billion and continues to eat cash. Its bonds are also in junk territory, a signal Level 3 could be at risk of default.

Where is all that debt going to end up? It would be an awfully heavy burden for a joint venture, and spinoffs have a tendency to be dumping grounds for unwanted debt. Sprint and Level 3 wouldn't be doing the new venture many favors if they saddled it with their debt load. Alternatively, if they do hold on to it, they will have a harder time paying it off after the long-distance revenues get transferred to the new venture.

Is It Really Worth It?
Then there's the question of what these long-distance businesses are really worth. Their value was called into question this week after Qwest (NYSE:Q) failed to sell off its long-haul fiber optic network. Struggling Qwest was hoping to get at least $2 billion for the network from a bigger player such as AT&T (NYSE:T) or Verizon (NYSE:VZ) but didn't get any takers.

Final Thoughts

If big players, with solid balance sheets, have no interest in upping their exposure, you have to wonder if investors shouldn't be thinking the same way? (Learn about the metrics that matter in the telecom industry in our article, Dial Up Choice Telecom Stocks.)



Filed Under: ,
Tickers in this Article: S, LVLT, T, VZ, Q

comments powered by Disqus

Trading Center