Don't hang up on Virgin Mobile IPO

Virgin Mobile USA, the prepaid wireless venture owned by Sprint Nextel (Symbol: S) and Richard Branson, is aiming to raise almost $500 million in an initial public offering next week. The company expects to price 27.5 million shares between $15 and $17 in a deal co-managed by Lehman Brothers, Merrill Lynch and Bear Stearns. Virgin Mobile will trade under the symbol “VM.” With a potential of 64 million shares outstanding if Sprint and Virgin convert all of their holdings to stock, that would give Virgin Mobile a market cap of just over $1 billion. The company will also have about $332 million of debt after the IPO on a pro forma basis.

What’s to like? First, Virgin Mobile is in the fast-growing and under-capacity prepaid wireless market. Like MetroPCS (PCS) and Leap Wireless (LEAP), Virgin sells phone and blocks of minutes without requiring multi-year contracts or imposing hefty cancellation fees. Second, all the good metrics for this industry are moving in the right direction for Virgin Mobile. Revenue was up 12% to $1.1 billion last year and rose another 24% in the first half of 2007. Operating and net losses have shrunk each year and Virgin actually showed net income of $29 million, or about 54 cents per fully diluted share, in the first half of 2007. Average revenue per user rose in the first half while the cost of acquiring new users slid.

It’s important to note that Virgin is a virtual carrier. Unlike MetroPCS or Leap, it doesn’t own any of the ultra valuable spectrum licenses sold at government auctions over the past decade. Instead, it relies on Sprint’s network.

The company’s structure after the IPO also may create a little nervousness. Public shareholders will own a portion of a company which in turn owns 83% of the limited partnership that actually runs the wireless company. Sprint will own the other 17% of the partnership directly along with its stake in the public company. Net income will be reduced by that 17% interest on a line accounting for “minority interest expense.”

So a hot brand in a hot niche growing rapidly - sounds like Virgin Mobile USA will have a hot debut. Still, with zillions of investors clamoring to get the limited number of shares, the first day of trading could push the price well beyond the bounds of rationality.

UPDATE: Commenter David Brian makes an important point below - if Sprint jumps in to compete with Virgin, the fox is into the hen house.

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