• Shares of Sprint and T-Mobile took a hit following the $26.5 billion announced merger between the two wireless companies a day earlier.
• Some investors doubted the regulatory viability, the deal's price tag and the projected $43 billion in synergies.
• Analysts at Wells Fargo downgraded both stocks from outperform to market perform Monday, and are 'moving to the sidelines' until there's a better sense of the 'regulatory pulse.'

Shares of Sprint and T-Mobile took a hit Monday after a blockbuster merger between the two telecom companies was announced over the weekend.

Some investors seem worried that the companies can overcome regulatory hurdles, while others may have been disappointed by the price tag, set at Friday's closing prices.

Sprint's stock fell roughly 14 percent, trading below $6, while T-Mobile was down 4.3 percent as of 3 p.m. ET.

Others on Wall Street doubted the $43 billion in synergies projected by the companies' management.

'We believe the merged firm would generate slightly less synergies than management assumes,' Jeffrey Kvaal, Nomura Securities managing director and analyst, wrote in a note to clients Monday.

The all-stock deal worth $26.5 billion announced Sunday would combine the nation's third- and fourth-largest wireless companies, bulking them up to a similar size to industry giants Verizon and AT&T. The combined company would take the T-Mobile name and be run by T-Mobile CEO John Legere.

The two wireless companies attempted and failed to combine in 2014 under the Obama administration. This attempt is also likely to face scrutiny from Donald Trump's White House, which has chafed at AT&T's proposed acquisition of Time Warner.

Analysts at Wells Fargo downgraded both stocks from 'outperform' to 'market perform' Monday, and are 'moving to the sidelines' due to concerns the stocks will be range-bound until the regulatory view becomes clearer.

'Our downgrade primarily reflects elevated regulatory scrutiny as an overhang on the shares,' Wells Fargo Securities senior analyst Jennifer Fritzsche said. Fritzsche said she discussed the deal with regulatory contacts, and their message was simple: 'This won't be easy.'

With no breakup fee in place, the burden of risk is more on Sprint than T-Mobile in terms of this regulatory uncertainty, Fritzsche said.

If T-Mobile succeeds, though, it could be in a strong position with deep spectrum assets, a well-perceived brand and a management team that has successfully integrated past acquisitions, she said.

'It would have the most impressive spectrum assets of any of the three remaining players,' Fritzsche said. 'But, as we have learned (multiple times) in the past, the M&A path is often not a linear one.'

Consumer advocacy groups have also voiced concern over T-Mobile's bid for Sprint, citing the risk of higher-priced cell phone plans because there is less competition.

On Sunday morning, Sprint (NYSE:S) and T-Mobile US (NASDAQ:TMUS) finally announced an agreement to merge after years of negotiations and speculation. Regardless of the news flow, Sprint shareholders aren't any closer to gains due to valuation and regulatory concerns similar to my investment thesis a few weeks back.

Source: John Legere on Twitter

Weak Deal Pricing

The wireless companies announced the deal valuation for Sprint at an enterprise value of $59 billion. The problem for shareholders is that the stock traded far above this range for most of 2017.

The all-stock transaction has an exchange ratio of 0.10256 of a T-Mobile share for each Sprint share. Based on T-Mobile ending last week at $64.52, the deal values Sprint at $6.62 per share. Depending on how TMUS trades when the market opens on Monday, S is likely to trade down from the $6.50 close.

The reason for the weak pricing is that Sprint is clearly in a desperate situation. Free screenwriting software downloads. The wireless company might have the spectrum for 5G, but it doesn't have the balance sheet to compete in the sector against AT&T (NYSE:T) and Verizon Communications (NYSE:VZ).

Sprint had $32 billion in debt at the end of 2017 and lacks the capacity to borrow for additional capital spending to build out a robust 5G network. One will note that Sprint issues more press releases on wireless spectrum-backed debt than updating the market on the 5G network progress with that spectrum.

Massive Regulatory Risk

The biggest issue with the deal is the lack of regulatory uncertainty and the general assumption that this deal won't get approved. Not only did AT&T and T-Mobile get blocked back in 2011 when the sector was more dominated by the industry giants, but the DOJ is now trying to block AT&T from merging with Time Warner (NYSE:TWX) in a vertical deal.

My previous research discussed the risks to consolidation to three national carriers due to the Canadian example. iMore calls the Canadian mobile market fast and expensive with limited distinction in the major network offerings for the iPhone. The lack of competition has left ARPU levels amongst the highest in the world, making the hurdle very high for Sprint and T-Mobile to prove a merger won't harm consumers.

AT&T just reported a quarter where the company lost 22,000 postpaid phone net subscribers, and analysts at Morgan Stanley (via FierceWireless) expect Sprint and T-Mobile to outperform. Possibly this deal is a harbinger that Sprint will miss these targets, but the recent results don't suggest the struggles warrants needing a merger. If anything, the results support the thesis of the FCC that 'effective competition' now exists in the domestic wireless market.

Beyond these issues, shareholders face a risk that isn't really that the deal gets blocked, but that the stock goes nowhere for 18 months. For various reasons, the AT&T/Time Warner deal and Qualcomm (NASDAQ:QCOM)/NXP Semiconductors (NASDAQ:NXPI) deals haven't offered much upside for shareholders holding through the regulatory process, with both mergers being consummated in October 2016.

In both of those cases, the shareholders had the opportunity to dump either Time Warner or NXP Semiconductors during the regulatory process as the stocks rose into expected approvals, while one would've done better with the S&P 500 index. The upside to those shareholders was the completion of deals letting them mostly cash out of their shares at premium valuations. The upside for Sprint is years after the completion of the deal. The upside occurs after the deal is completed, once the $6 billion in estimated run rate cost synergies are realized over multiple years along with the elimination of the domestic price wars.

Source: Sprint/T-Mobile merger presentation

Sprint isn't likely to rise above the offer price until regulatory risk is gone, and that isn't going to happen with T-Mobile dominating the domestic wireless service growth and subscription additions. Basically, the stock has no upside on a deal and throughout a messy regulatory approval process.

Takeaway

The key investor takeaway is that the long-term value of a Sprint/T-Mobile deal is in the cost synergies of a combined 5G network and reduced competitive scenario in the domestic wireless sector once a merger is approved by regulators. The value doesn't exist for Sprint shareholders from a merger agreement, but rather not until completing a positive regulatory ordeal.

Similar to the reasons last year, Sprint appears desperate for a merger, and shareholders will never win in that situation. The wireless company will be in bad shape after spending billions to complete a failed merger, so the downside risk is significant.

Disclosure:I am/we are long TWX.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.