AT&T Inc. (T), Leap Wireless International, Inc. (LEAP): Not a Big Leap, But Still Important

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After getting shot down in its attempt to buy T-MobileAT&T Inc. (NYSE:T) has been forced toward smaller deals to satisfy its spectrum needs. The proposed purchase of Leap Wireless International, Inc. (NASDAQ:LEAP) is expensive, but a good fit.

Getting Bigger

AT&T Inc. (NYSE:T)The bigger you are in the telecom space, the better. AT&T Inc. (NYSE:T) and Verizon Communications Inc. (NYSE:VZ) are so large that they have an effective duopoly in U.S. cell service. That gives them economies of scale and large annuity like customer bases.

AT&T Inc. (NYSE:T) sought to leapfrog Verizon Communications Inc. (NYSE:VZ) as the largest U.S. largest cell outfit by buying T-Mobile. That purchase, which didn’t work out, would have brought with it both customers and increasingly-valuable spectrum. T-Mobile has since merged with fellow second-stringer MetroPCS. And the duo are using their increased scale to nip at AT&T’s heels with cheap phone deals and low rates. That has to sting a little.

Still in need of spectrum, AT&T Inc. (NYSE:T) has been buying it piecemeal. That’s a bigger deal than many may believe. For example, AT&T bought customers and spectrum from Atlantic Tele-Network for $780 million in early January. Verizon sold that business to Atlantic in 2010 for $223 million.

Now AT&T Inc. (NYSE:T) is buying Leap Wireless International, Inc. (NASDAQ:LEAP) for $1.2 billion, an almost 90% premium over the company’s value the day prior to the announcement. The deal will be beneficial, for sure, but buying in tiny increments is only going to get more and more expensive.

For Leap Wireless International, Inc. (NASDAQ:LEAP) shareholders this all cash deal is a windfall. Although the top-line has been making steady, though hardly impressive, progress over the past eight years, the bottom-line has been mired in red ink for seven years. Investors should sell to lock in their gains, since Leap shares would likely fall hard if the AT&T deal doesn’t go through.

A Better Competitor

The Leap Wireless International, Inc. (NASDAQ:LEAP) deal will solidify AT&T’s second place status, not vault it into the lead. That said, Leap has a solid offering in the pay-as-you-go category and, of course, spectrum. AT&T shareholders should be generally happy with the deal.

Indeed, AT&T’s top-line has grown only modestly over the last four years, moving from $123 billion to $127 billion. While Leap Wireless International, Inc. (NASDAQ:LEAP)’s $3 billion in revenue won’t change that trend, it at least keeps the top-line heading in the right direction. The bigger problem is that earnings have fallen over that span, which won’t be helped at all by Leap’s losses. Being part of a bigger player, though, should allow AT&T to pare Leap’s cost structure.

Bigger, but More Expensive

Verizon is the company to beat in the U.S. market. It was looking at buying the 49% of Verizon Wireless that it doesn’t own from Vodafone Group Plc (ADR) (NASDAQ:VOD), but that is likely to cost over $100 billion. Instead, Verizon is rumored to be looking at the Canadian market. That would be a great move in many ways, since Canada is, literally, right next door.

Canadian telecoms TELUS Corporation (USA) (NYSE:TU), Rogers Communications Inc. (USA) (NYSE:RCI), and BCE Inc. (USA) (NYSE:BCE) all fell sharply on the news that Verizon was looking north. However, the rumor is that Verizon would start off by purchasing tiny upstarts and growing the business from there. While growth might be swift, taking on the mature market’s giants would be expensive.

Although the growth prospects of a Canadian deal are interesting, Verizon’s yield is around 4.1% compared to AT&T’s 5%, despite their many similarities. Verizon is performing better of late, but not enough to justify a near 20% yield premium. For example, Verizon’s top line has gone from $107 billion to $115 billion, better than AT&T’s top-line growth, but not much. And, like AT&T, earnings have been heading lower.

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