by Investing Daily, Investing Daily
— this post authored by Scott Chan
Investing Daily Article of the Week
Merger talks between T-Mobile (Nasdaq: TMUS) and Sprint (NYSE: S) are again heating up, with a deal reportedly possible by the end of October. In recent years, T-Mobile was close to a deal with AT&T (NYSE: T) in 2011 and Sprint in 2014, but both prospective deals broke apart due to expected stiff opposition based on anti-trust grounds from the Obama administration. The difference now is that the Trump administration, regarded as more pro-business, is in power and chances of regulatory approval is higher.
Given the significance of the possible merger, which would reduce the number of U.S. national wireless carriers to three, there should still be some regulatory scrutiny. For example, consumers have enjoyed lower pricing and benefited from more unlimited call and data plan offerings thanks to the intense competition among wireless carriers to snatch market share from competitors in a saturated U.S. market, so a merger of the two companies most aggressively competing on price could be perceived as anti-consumer. Last week’s confirmation of Makan Delrahim as the chief of the Department of Justice’s antitrust unit, however, seems to bode well for the probability of approval. Delrahim has a background as a pro-merger lobbyist.
The combined entity would have about 130 million subscribers, still behind Verizon’s 147 million (NYSE: VZ) and AT&T’s 136 million, but the merger clearly would close the gap significantly. The biggest benefit is the potential cost savings. Wireless is a very high fixed-cost business. Combining the two companies should enable the combined entity to save at least $1 billion a year, and perhaps as much as $3 billion to $5 once the integration is complete. However, since T-Mobile and Sprint use mutually incompatible mobile technologies (GSM versus CDMA), integration could be time consuming and bumpy.
The rumored deal is reported to be all stock, and the exchange ratio will be “at market.” T-Mobile’s majority owner, Deutsche Telekom (ETR: DTE) would probably remain the majority shareholder.
If the potential merger does come to fruition, it would occur as the wireless industry is on the cusp of rolling out next-generation technology – 5G. Sprint, thanks to a previous acquisition, owns a large amount of unused spectrum, that could be used for the upcoming 5G deployment.
The FCC controls what frequencies of the spectrum can be used for what purpose. It has designated a finite spectrum, between 700 MHz and 2.6 GHz, to be used for cellular phones and divided up this spectrum into blocks and auctioned them to various carriers. As mobile data usage has exploded, the need for addition spectrum to accommodate the huge demand has also grown. But, the amount of spectrum available is finite. Hence, Sprint’s ownership of a deep unused spectrum portfolio could be a very significant edge.
In the case of T-Mobile, in recent years it has leap-frogged Sprint to become the third-largest U.S. carrier by subscriber count. Its aggressive marketing strategy has also resulted in the fastest-growing subscriber base in the nation. According to a survey, the subscriber base is also the most loyal, with a quarter of its subscriber base reporting that it won’t switch carriers for anything. No other carrier scored higher than 16 percent.
Assuming a merger indeed occurs, the resulting company should be better able to compete with the Big Two of Verizon and AT&T. Since Verizon and AT&T’s plans tend to be more expensive, the combined company will be able to charge higher rates but still undercut the Big Two in pricing while offering comparable network quality. The two companies’ networks would combine – with Sprint’s CDMA technology likely to be phased out. Expected higher pricing and synergetic savings would then result in better margins than either company could muster on its own.
The potential merger is seen as a likely “win-win” scenario for the two companies, which explains why investors reacted positively to the report that a deal was close.
Of course, excited as a potential deal may be, talks could still break down if Sprint holds out for a better deal – it’s known to have talked with Charter Communications (Nasdaq: CHTR) – or if Washington gives a thumbs down. Additionally, Wall Street’s history is littered with failed mergers and acquisitions so even a merger is no guarantee of improvements in profitability. However, there’s no doubt that a merger would be a ground-shaking event for the U.S. wireless industry and this is a situation that bears watching.
