Merrill Lynch is out in defense of Sprint (NYSE:S) noting the stock sold off 14% after announcing improved Q2 operating metrics and a $3bn convertible. Investors seem concerned that the convertible could limit take-over potential, although terms have not yet been announced. They doubt that Sprint would restrict its M&A options for the sake of better terms on $3bn. In the near term, the firm expect a bounce. For longer-term outperformance, they would need better visibility on the path to subscriber base stabilization and margin improvement.

Sprint’s operating performance has improved but is not yet stable, with wireless service revenues down 11.2% y/y. The highlight was a 45bps+ reduction in postpaid churn (to <2.0%), but with soft gross adds, postpaid subs declined by 776K (MLe: 1.0mn). Guidance for 3Q08 was slightly downbeat, with postpaid subscriber losses to worsen and EBITDA to decline. Management guidance has been consistently conservative, although they do believe that AT&T’s 3G iPhone launch and a weak economy are hurting Sprint.

Notablecalls: I like this one. We may get a bounce.

Also note that Pali is out upgrading S to Buy this AM.