Will Sprint and T-Mobile Merge?

by Tony D'Altorio

Will Sprint and T-Mobile Merge?

by Tony D'Altorio, Investment U Research

Monday, March 14, 2011

2011 may become the year that large, struggling companies join forces to try reviving their fortunes.

Nokia ADR (NYSE: NOK) and Microsoft (Nasdaq: MSFT) certainly did just that when they joined forces in the smartphone market. And now Sprint (NYSE: S) and T-Mobile USA - the besieged U.S. mobile phone business of Deutsche Telekom ADR (PINK: DTEGY) - might try the same.

The underperforming companies already began discussions on creating a new U.S. entity where each would hold a 50% stake. They have good reason to do so...

After all, Verizon (NYSE: VZ) and AT&T (NYSE: T) dominate the U.S. wireless market. AT&T has 95.5 million mobile customers, Verizon Wireless has 87.5 million, Sprint has 49.9 million and T-Mobile USA has just 33.7 million.

Verizon and AT&T Rule the Airwaves

At least in part, Verizon and AT&T reached those impressive figures through acquisitions.

They're now solidifying their holds by basing new networks on LTE, a fourth generation wireless technology. That allows them to capitalize on surging smartphone demand.

Yet Sprint and Deutsche Telekom's T-Mobile have been leaking customers like a sieve over the past few years. Sprint particularly keeps reporting losses after its disastrous $36 billion takeover of Nextel in 2005.

Meanwhile, T-Mobile's revenues and earnings really began falling in 2009 due to its failure to keep up with rivals and build a 3G network. 2010 alone saw it lose 390,000 contract customers - 318,000 in the fourth quarter alone - despite finally upgrading.

But together, the two might stand a chance.

Deutsche Telekom already has experience in making turnaround business deals. Last year, it and France Telecom (NYSE: FTE) combined their underperforming British mobile businesses into a UK entity, with each of them holding a 50% stake.

Together, they created the largest UK mobile operator called Everything Everywhere. It is supposed to improve its standing by securing cost savings synergies of about $5.7 billion.

A similar deal between T-Mobile and Sprint would give the combined company nearly as many customers as its rivals. But that doesn't automatically mean it's worth it.

Sprint and T-Mobile Merger Difficulties

Merging Sprint and T-Mobile USA makes for a tricky situation. The two companies use different wireless technologies in their mobile networks.

But that problem goes away if they just use LTE technology for 4G mobile services. Fortunately, they're currently considering that option.

Yet even if they do, their egos could still trip them up badly. Both of them want a controlling stake in the combined entity, refusing to settle for a 50-50 split.

  • Sprint says it has more customers and generated more revenue last year.
  • But Deutsche Telekom says it reported more EBITDA profits since it has more high-paying customers tied to monthly contracts.

According to Robin Bienenstock, a Bernstein telecoms analyst, T-Mobile USA has an equity value of $26.8 billion, while Sprint has merely $19.8 billion. But while it therefore makes sense that Deutsche Telekom holds onto at least 50%, Sprint wants what it wants.

That's too bad, since the two really could help each other out. Bernstein calculates their potential synergies from such a deal at up to 45% of the total value of the combined company.

Deutsche Telekom might try wearing Sprint down, since it has short-term protection at least. Thanks to its network build-out, it has a temporary advantage over the competition.

It also has options Sprint doesn't, with the financial firepower to either buy more radio spectrum itself or buy it from another company to expand its 4G service.

But the best option for both businesses remains an eventual union of the two. Here's hoping their top management can check their egos at the door.

Good investing,

Tony D'Altorio

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