NEW YORK - Citigroup upgraded No. 3 U.S. mobile service Sprint Nextel Corp to a buy rating citing a possible tie-up with Deutsche Telekom AG and expectations of improvement in subscriber numbers.

Shares of Sprint, which has been working for years to stem customer losses, rose 6 percent even as other analysts voiced skepticism that the long-rumored deal would happen. The two companies use incompatible network technologies.

Sprint declined comment and a representative for Deutsche Telekom was not immediately available for comment.

Citigroup analyst Terence Sinclair has a price target of $5.50 on the stock.

Sinclair said Deutsche Telekom, owner of the No 4 U.S. mobile service T-Mobile USA, could merge with Sprint by making a minimal payment.

Sinclair noted that Deutsche Telekom had dismissed the idea of combining with Sprint in 2007, but Citigroup said the U.S. cellular market has since become more challenging.

Citigroup said there was a 55 percent chance that Sprint would look for a merger with T-Mobile USA in the first half of next year.

But analyst Walter Piecyk of Pali Research said there was only a 2 percent chance that DT would buy Sprint within the next two years.

In fact, we think its more likely that DT structures a transaction with the cable companies to use their spectrum to build out a nationwide (high-speed wireless) network in a new joint venture, Piecyk said in a research note. He added that scenario had a low probability of occurring.

Cable providers including Comcast Corp and Time Warner Cable are part owners of Clearwire Corp, a wireless venture in which Sprint has a majority ownership.

Both Sprint and T-Mobile USA have had trouble competing against market leader Verizon Wireless - a joint venture between Verizon Communications Inc and Vodafone Group Plc and against No. 2 U.S. provider AT&T Inc.

Sinclair sees Sprint's losses shrinking over the next six months and the company generating 2010 operating income before depreciation and amortization near current consensus.

Citigroup has a buy rating and a price target of 10.70 euros on Deutsche Telekom's stock.

Shares of Sprint Nextel were trading up 6 percent at $4.15 in early afternoon trade on New York Stock Exchange. They earlier touched a high of $4.41. (Reporting by Sinead Carew; additional reporting by Sayantani Ghosh in Bangalore; editing by Sweta Singh, John Wallace, Leslie Gevirtz)

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