Wireless Watch: Sprint's acquisition of Virgin Mobile could be risky

A decade ago, big wireless carriers steered clear of prepaid customers. In general, these users paid less per month than people who signed contracts, and didn't stay with their carriers as long. Further, they tended to be an unsavory group, often unable to pass a credit check.

However, as wireless plans become more expensive and recession-wary customers cut back on their expenses, the market for prepaid customers is looking better than ever. That's why Sprint Nextel (S), which already owns 13% of Virgin Mobile USA (VM), announced today that it will acquire the rest of the company for $483 million.

Virgin Mobile has long operated as an MVNO, a mobile virtual network operator that offers its own service, but piggybacks on an existing carrier's network. Given that Virgin currently uses Sprint's network, Sprint's acquisition of the brand amounts to a consolidation of its prepaid customer base. Under the terms of the deal, Sprint will give Virgin Mobile shareholders Sprint shares valued at $5.50 per share. That is a 31 percent premium to the stock's closing price on Monday. Sprint says that, as part of the deal, it will retire all of Virgin Mobile's debt, which is expected to be around $205 million at the end of September.

Sprint already owns Boost Mobile, another popular prepaid service. At the beginning of the year, Boost offered unlimited voice, text and web access -- as well as its Nextel walkie-talkie service -- for $50 per month. During the first quarter, it brought in 764,000 net prepaid subscribers, a welcome contrast to Sprint's postpaid business, which lost 1.25 million customers over the same period.

The current plan is to combine Virgin and Boost into one prepaid business group in Sprint's organization. Each company will continue to operate as a separate organization, serving its existing customers and bringing in new ones. Dan Schulman, the chief executive of Virgin Mobile, will run Sprint's prepaid business once the transaction has closed; Matt Carter will continue to run Boost Mobile and will report to Schulman.

Sprint's decision to move deeper into the prepaid market validates the importance of this market segment, but also generates a number of questions. There are already several big prepaid operators, including Leap Wireless (LEAP) and MetroPCS Communications (PCS), which have long-running, successful prepaid businesses. As Sprint (and, perhaps, AT&T (T) and Verizon (VZ)) try to break into their sandboxes, they risk cannibalizing their existing, higher-margin businesses. Besides that, a prepaid business that customers can drop at any time is far less stable -- and has less stable revenues -- than a postpaid business in which customers sign two year contracts. The big carriers will need to understand how to sell these prepaid services in a different manner and will have to develop a way of accounting for their sales.

For Sprint, the acquisition looks like a good strategy, but investors should realize that perhaps the worst thing for the prepaid business could be a true economic recovery. Faced with real economic stability, the prepaid business could founder as people increasingly opt for all the bells and whistles that come with more expensive, two-year plans.

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