INSIGHT: Dusting Off the Sprint/T-Mobile Merger

It now appears, since the Department of Justice has signed off on the deal, that the historic combination of T-Mobile US Inc. and Sprint Corp. will, assuming the attorneys general of the various states fall into line, be allowed to proceed. As a condition of the DOJ’s approval, of course, the combined company will be required to divest certain assets, intended to enable DISH to establish its own wireless network, thus ensuring a sufficiently competitive marketplace for these services.

The structure of the Sprint/T-Mobile combination is unusual and could be altered if the attorneys for the companies are unable to deliver an opinion that the transaction, as presently contemplated, qualifies as a reorganization within the meaning of tax code Section 368(a), according to filings with the Securities and Exchange Commission.

Approximately 85% of the stock of Sprint is owned by affiliates of SoftBank—Starburst I Inc. and Galaxy Investment Holdings Inc. The business combination envisions, first, a merger of each of Starburst and Galaxy with and into Merger Co., a newly created limited liability company (which we imagine will elect to be treated as an association taxable as a corporation), wholly owned by T-Mobile. In the merger, the shareholder(s) of Starburst and Galaxy will receive, in exchange for each share of its stock, 0.10256 of a share of T-Mobile.

Next, Merger Sub, a wholly owned subsidiary of Merger Co., will be merged with and into Sprint, with Sprint continuing as the surviving corporation and as an indirect wholly owned subsidiary of T-Mobile. In this merger, the shares of Sprint not previously exchanged for T-Mobile stock will be so exchanged and the holders of such Sprint stock will receive, for each share thereof, 0.10256 of a share of T-Mobile.

Thus, when the dust settles, T-Mobile will own all of the stock of Merger Co. and the latter will own all of the stock of Sprint. Merger Sub will have gone out of existence as a consequence of its merger with Sprint, and Starburst and Galaxy will have met a similar fate, as a result of their mergers with and into Merger Co. Approximately 31% of the stock of T-Mobile will be in public hands following the mergers, with the balance owned by SoftBank and Deutsche Telekom AG.

Bad ’B’ Reorganization?

It is intended that each of the mergers described above qualify as a reorganization. It seems certain that the Starburst and Galaxy mergers will so qualify. However, the Merger Sub and Sprint merger has some hurdles to overcome.

That merger cannot qualify as an ’A’ reorganization, by reason of Section 368(a)(2)(E), because stock of a corporation in control of the merged corporation is not being “used” in the transaction to compensate the shareholders of Sprint. Instead, stock of the “grandparent” of the merged corporation is being so used (to compensate the shareholders of the acquired corporation) and the statute does not permit that form of consideration. See Revenue Ruling 74-564.

Thus, we are left with a ’B’ reorganization as the only type of reorganization available with respect to the Merger Sub/Sprint merger. A ’B’ reorganization is defined in Section 368(a)(1)(B) as “the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control (as defined in Section 368(c)) of such other corporation.”

In the instant case, Merger Co. will be in control of Sprint immediately after the acquisition of the stock of Sprint from the shareholders of Sprint. The question, however, is whether all of the stock of Sprint will have been acquired solely in exchange for voting stock of T-Mobile.

Approximately 85% of the stock of Sprint will have been acquired in the merger of Starburst and Galaxy with and into Merger Co. If, in those mergers, Merger Co. assumes any liabilities of Starburst and/or Galaxy, the stock of Sprint will not have been acquired solely in exchange for voting stock of T-Mobile as required by Section 368(a)(1)(B). In that event the acquisition by Merger Co. of all of the stock of Sprint is not a ’B’ reorganization, and the acquisition of the 15% of Sprint stock owned by the minority shareholders of Sprint will not qualify as a reorganization since that acquisition is part of an overall plan which includes the “tainted” acquisition of the Sprint stock held by Starburst and/or Galaxy. See Rev. Rul. 70-65.

Thus, the qualification of the “reverse merger” (of Merger Sub with and into Sprint) as a reorganization depends, entirely, on whether the merger of Starburst and Galaxy with and into Merger Co. entails the assumption of liabilities of either or both of those corporations. If it does, presumably, the attorneys will not be able to render the necessary opinion. In that event, the transaction would have to be restructured. The restructured transaction, which would eschew the Starburst and Galaxy mergers, and feature, simply, a reverse merger of Merger Sub with and into Sprint, would qualify as a ’B’ reorganization since, in that case, there would be no liability assumption and, therefore, the sole consideration given by Merger Co. to the shareholders of Sprint in exchange for their stock therein would be “acceptable” consideration, i.e., voting stock of T-Mobile.

Net Operating Losses

Sprint, at last count, has accumulated approximately $21 billion in Federal net operating losses. It seems likely that the acquisition of Sprint’s stock by Merger Co. will give rise to an “ownership change” with respect to Sprint. That means that its NOLs will become subject to the “Section 382 limitation,” such that limitations will be placed on the amount of taxable income, for any post-change year, that the pre-change NOLs are permitted to offset. This limitation can be increased by “recognized built-in gains,” i.e., gains from the sale of assets, owned at the time of the ownership change, that are sold or disposed of during the five-year recognition period, i.e., the five-year period beginning on the date of the ownership change.

Accordingly, since the forced sale of assets to DISH will take place within the recognition period, it seems likely that the gains from those sales will constitute recognized built-in gains, which means that those gains will be eligible to be sheltered by Sprint’s pre-change NOLs.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.