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In a surprise move, Sprint Nextel is to acquire the largest US MVNO, Virgin Mobile, which should reinforce its highest growth business, the prepaid, flat rate services offered by its Boost Mobile subsidiary, but also increase its dependence on low margin customers.

Sprint will pay $5.50 a share for the MVNO - in which it already holds a 13.1% stake and which rides on the Sprint CDMA network - valuing the deal at $483m. The transaction should close in the fourth quarter or the start of 2010 and represents a 31% premium over Virgin Mobile's closing price on Monday. Sprint also agreed to retire Virgin's outstanding debt of an estimated $205m when the deal closes.

Sprint Nextel's last couple of quarters have seen increasing success for Boost, which hit the headlines with its $50-a-month unlimited deal. Because it mainly uses the iDEN network that Sprint acquired with Nextel, Boost has stronger economics than many flat rate offerings, using a great deal of capacity that would otherwise be wasted. However, it has seen a rising number of challengers from flat rate specialists Leap and MetroPCS and new MVNO offerings like TracFone. And given that one of the key problems for Sprint in the past two years has been defection of high margin customers, the acquisition of Virgin can only accelerate the worrying shift of the carrier's profile towards the low end.

In a prepaid business that depends on scale, though, outright control of Virgin will put Sprint in pole position, even against the mutual roaming deal of Leap and MetroPCS and the stepped-up prepaid activities of T-Mobile USA. As well as a strong prepaid position, the cellco also says its new purchase will bring it enhanced cross-selling of products and services across a larger target audience, new managerial talent, and free cashflow accretive for Sprint.

It gains 5m customers, doubling the size of its prepaid business overnight, without any new strain on its network, since these users are already on its CDMA system - though it will take on the costs of acquiring and supporting these users directly. And it takes on the problems that prompted Virgin to sell its MVNO - a declining customer base and the threat of insufficient cashflow to pay off $100m in debt that matures at the end of 2010. Pali Research says the purchase amounts to paying $130 per Virgin subscriber, slightly more than it costs the MVNO to buy a new customer. In a research note, Pali said the deal was "a mild negative for Leap and MetroPCS", since Virgin, which had not pushed much into their unlimited prepaid space, will now do so more aggressively once its offerings are more integrated with Boost's. It also questioned whether Sprint would maintain the two brands or consolidate them.

Analysts at TownHall Investment Research were positive about the price paid. "Dividing the deal price by customers implies $132 per customer value. This is about half the value of the anticipated revenue stream from current customers assuming Virgin's last quarter customer population (5.28m), churn (5.1% for an average life of 13.3 months), and the risk-free rate of 3%. It is also well below the $1,500 to $2,500 enterprise value per subscriber achieved by MetroPCS and Leap .... Last quarter Virgin's churn was 5.1%, appreciably better than Sprint's prepaid churn of 6.9% although its ARPU of $20.08 is lower than Sprint's prepaid ARPU of $31." The research note added: "Virgin is a great marketer and Sprint could use all the marketing help it can get."

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