AT&T Merger with T-Mobile: Is Efficiency Worth Reduced Competition?

Buyout premiums get the headlines in mergers and acquisitions, with much of the commentary devoted to who got the better end of the deal. When a deal involves stock, however, the greater benefits almost always come in the longer term – i.e., as capital appreciation and dividend growth after the deal is done.

— Roger Conrad, MLP Profits

When it comes to wireless telecommunications, it’s a dog-eat-dog world. Do three national wireless carriers provide enough competition to benefit U.S. mobile users? That’s the question U.S. regulators will need to decide after AT&T (NYSE: T) announced that it was acquiring T-Mobile USADeutsche Telekom’s (Other OTC: DTEGY.PK) U.S. wireless subsidiary – for $39 billion. Sounds like a lot of money, but it’s actually less than the $50.7 billion Deutsche Telekom paid for T-Mobile (then called VoiceStream Wireless) 10½  years ago.

T-Mobile has always struggled to compete in the U.S. cellular marketplace and has been a financial-writedown nightmare for German parent Deutsche Telekom. That may explain why Deutsche Telekom’s stock jumped more 11% yesterday on the news that it was ridding itself of its problem child. AT&T’s stock only rose a less stellar 1%, probably due to investor concern that Ma Bell was paying too high of a price. Prior to the merger announcement, analysts estimated that T-Mobile was worth only between $15 billion and $25 billion

AT&T-T Mobile Merger Details

As for deal specifics, the purchase price is $25 billion in cash and $14 billion in AT&T stock. If the merger doesn’t get Department of Justice and Federal Communications Commission regulatory approval, AT&T agreed to pay Deutsche Telekom a $3 billion (7.5%) breakup fee and some wireless spectrum. A breakup fee worth 7.5% of the deal value is extremely high since the average breakup fee is only 3%. What a great deal for Deutsche Telekom!  It wins big even if it loses, which is the type of deal I thought only Warren Buffett could finagle. AT&T must really want T-Mobile and be fairly confident that it can get regulatory approval.

AT&T-T Mobile Merger Would Greatly Benefit AT&T

AT&T wants T-Mobile so badly for a number of reasons. First, adding T-Mobile’s 33.7 million subscribers would make AT&T the largest U.S. wireless carrier with 130 million subscribers and 42% market share, leapfrogging over the 33% market share and 100 million subscribers of arch nemesis Verizon Wireless — owned 55%-45% by Verizon (NYSE: VZ) and Vodafone (NYSE: VOD), respectively. AT&T estimates that the merger would create synergies equal to $3 billion in cost savings per year. On a net present value basis, AT&T states that these cost savings alone are larger than the $39 billion acquisition cost!

Roger Conrad, co-editor of MLP Profits, explained in an article entitled “The Next Merger Wave” why bigger is better in capital-intensive industries (which wireless telecommunications definitely is):

Utility mergers and acquisitions are uniquely successful because essential services are fundamentally scale industries. The added complexity of becoming larger companies is far offset by the cost savings and business synergies.

One reason is better access to capital. Building and maintaining network assets is enormously capital intensive. Larger companies can always raise capital more easily for such projects than smaller ones. Larger utilities can also spread system costs less onerously, since they have more people to bill.

Second, combining T-Mobile’s cell towers with AT&T’s in major metropolitan areas would increase AT&T’s network density by approximately 30 percent. The denser a wireless network, the better its quality because there is a greater capacity to handle voice calls and data at top transmission speeds without the risk of dropping them when users move between cell towers. Furthermore, more cell towers in AT&T’s heavy-usage cities would increase AT&T’s spectrum availability, which is important in a wireless world that is becoming all about data downloads – including megabyte-heavy video. Bottom line, if AT&T has a wireless problem, service quality is it and T-Mobile would immediately help solve the problem. If AT&T had to improve its service quality all by itself by building new cell towers, it would take AT&T five years or longer in most of its top cities.

Third, swallowing up T-Mobile would eliminate one of its three other national competitors. Less competition would mean higher prices and profits for AT&T. T-Mobile currently offers a $10 per month plan for 200 MB of data, which is much cheaper than AT&T’s lowest-price data plan costing $14.99. I sincerely doubt that T-Mobile’s $10 per month plan would survive the merger! Industry consolidation can help other surviving carriers, not just the acquiring carrier. The stocks of both Verizon and Vodafone rose more than AT&T on Monday, perhaps because Verizon Wireless would benefit from the higher prices inherent in industry consolidation almost as much as AT&T would and without spending a penny, let alone $39 billion. 

AT&T-T Mobile Merger Could Be Anti-Competitive

So, the question for regulators is whether cost efficiencies and improved services outweigh higher prices. Based on the Sherman anti-trust act and the Department of Justice merger guidelines, I think the answer has to be “no.” AT&T argues that even without T-Mobile, the company will face strong competition — in 18 of the top 20 U.S. local markets, there are five or more wireless providers to choose from.  But this is misleading. As the New York Times notes, local competition tells only half of the story because it neglects the issue of roaming charges, which apply when a person calls someone outside of their local service area:

National competition also plays an important role in the wireless market. Many mobile phone customers base their buying decisions on whether they will have to pay expensive roaming charges when they travel out of their home area. And after the merger, AT&T and Verizon will between them control nearly 80 percent of the wireless market, with the third-largest competitor, Sprint, lagging far behind.

Merger Winners

If the merger is approved, the big winners would be the seller (Deutsche Telekom) and the buyer (AT&T). Other likely winners:

  • Apple (NasdaqGS: AAPL). iPhones could be sold to T-Mobile’s 33.7 million subscribers for the first time and current iPhone users on AT&T’s network would be less likely to leave.
  • Verizon Wireless. Would benefit from fewer total competitors, but would be hurt by a stronger No. 1 competitor in AT&T. A possible.
  • U.S. Cellular (NYSE: USM), MetroPCS (NYSE: PCS), and LEAP Wireless (NasdaqGS: LEAP). Would become prime takeover targets for Sprint and other wireless carriers who need to bulk up quickly to compete.
  • JP Morgan (NYSE: JPM), which is advising AT&T, and Morgan Stanley (NYSE: MS), which is advising Deutsche Telekom. Both investment banks are primed to make huge multi-million dollar fees if the deal goes through.

Merger Losers

The number of losers would be much bigger. First up is Sprint Nextel (NYSE: S), which is the third-largest national carrier but a very distant third at only 50 million subscribers. It had desperately wanted to buy T-Mobile, but it couldn’t match AT&T’s financial fire power in offering Deutsche Telekom the best takeover price. Sprint can’t compete in coverage area or data download capacity with either AT&T or Verizon Wireless. Superstar investor David Einhorn’s big bet on Sprint isn’t looking too good right now.

I suppose Sprint could become a takeover target itself, but both AT&T and Verizon are large enough already and other potential acquirers (Comcast, Time Warner Cable, Google, Cisco) may not want to make the same mistake that Deutsche Telekom made a decade ago with VoiceStream by acquiring a second-tier player that can’t compete. Other likely losers:

  • Brightpoint (NasdaqGS: CELL). More than 10% of the wireless supply-chain manager’s revenues is with T-Mobile. AT&T has its own people doing logistical work, so say goodbye to these revenues, Brightpoint.
  • American Tower (NYSE: AMT), Crown Castle (NYSE: CCI), and SBA Communications (NasdaqGS: SBAC). All of these cellphone tower companies would lose business because AT&T would need less tower construction.
  • Clearwire (NasdaqGS: CLWR). Money-losing owner of WIMAX wireless spectrum was planning on selling some spectrum to T-Mobile, but that won’t happen now. Sprint owns 54% of Clearwire, so Sprint is a double loser.
  • Google (NasdaqGS: GOOG) and Motorola Mobility (NYSE: MMI). Apple’s iPhone wasn’t available on T-Mobile’s network, providing Google’s Android-based software and Motorola’s Droid handsets with an opening to grow market share. No longer the case.
  • U.S. Consumers? This is the big question mark that will decide the fate of the AT&T-T Mobile merger. Although biased, Sprint has issued a statement via email arguing against the deal, claiming that increased market concentration would harm consumers:

If approved, the merger would result in a wireless industry dominated overwhelmingly by two vertically-integrated companies that control almost 80% of the US wireless post-paid market, as well as the availability and price of key inputs such as backhaul and access needed by other wireless companies to compete. The DOJ and the FCC must decide if this transaction is in the best interest of consumers and the US economy overall, and determine if innovation and robust competition would be impacted adversely by this dramatic change in the structure of the industry.

Credit is Cheap and Available

If the merger goes through, JP Morgan would actually be a double winner. Not only would it get M&A advisory fees, but it would get fees and interest payments from a $20 billion loan it is ready to provide AT&T to finance the takeover. This loan would be the biggest in JP Morgan history. Even if the merger doesn’t get regulatory approval, the loan is important because it provides evidence that the U.S. economic recovery continues. Banks are willing to lend and, perhaps more importantly, corporations want to borrow.

Cheap and available financing is important not only for telecommunications companies, but also for master limited partnerships (MLPs) in the energy space. As Roger Conrad of MLP Profits has recently written:

There’s no doubt equity as well as debt financing makes sense for MLPs as rarely before, provided, of course, there are worthwhile projects and acquisitions to spend it on. And with the cost so low, even very low-risk projects generate generous returns. In other words, not only is potential growth greater but MLPs can take less risk to get at it.

Find the Best Tax-Advantaged MLPs with the Help of MLP Profits!

With oil prices rising and credit cheap and readily available, energy-based MLPs will continue to thrive and generate higher tax-advantaged cash distributions. Unlike wireless telecommunications companies, all energy-based MLPs pay out cash distributions in the form of “return of capital” that is not taxed. As Roger Conrad, co-editor of the market-beating MLP Profits investment service, recently reminded subscribers:

MLPs are tax advantaged, as return of capital isn’t taxed in the year received but only as a capital gain when MLP units are sold. Further, our favorites’ real appeal is that they’re dividend growth machines that will only run faster as the economy picks up steam.

To find out the specific names of the energy MLPs Roger likes best right now, give MLP Profits a try today!