Following intense speculation surrounding the potential of Sprint (NYSE:S) acquiring rival T-Mobile (NASDAQ:TMUS) for the last six months, the two companies appear to have reached a tentative deal, according to media reports. (Sprint, T-Mobile Said Near Price, Termination Fee Accord, Bloomberg, June 6, 2014) Under preliminary terms of the reported deal, Sprint is likely to pay around $40 per share for T-Mobile, valuing the company’s equity at close to $32 billion. Sprint would also assume T-Mobile’s net debt of about $9 billion, adding to its ever-burgeoning debt load, which at the end of Q1 2014 was $26.6 billion.
Both companies were wary of the FCC blocking the merger earlier, considering the potential anti-competitive nature of the deal. However, recent revisions in spectrum auction rules and debates over net neutrality at the FCC seem to have found favor with both companies, which is likely to have encouraged them to go ahead with the merger. The industry’s shift towards consolidation, witnessed recently with Time Warner merging with Comcast and AT&T‘s (NYSE:T) plans to acquire DirecTV (DTV), is also likely to have given confidence to Sprint and its Tokyo-based majority owner SoftBank (OTCPK:SFTBY) to pursue the deal.
If the deal goes through and is approved by regulators, the Sprint-T-Mobile entity would have a share of about 30% of the U.S. wireless market. This would enable it to better compete with market leaders Verizon (NYSE:VZ) and AT&T, although consumers would then have one less service provider to choose from. However, if the deal falls through for any reason, Sprint could end up paying over $1 billion in cash as break-up fee to its smaller rival.
Our price estimate for Sprint is about $8.50, which is slightly below the current market price.
Sprint’s efforts at a deal could face tough opposition from antitrust regulators, who might fret over having one less national carrier and therefore less competition in the industry. Two years ago, a similar bid for T-Mobile by AT&T was abandoned due to anti-competitive concerns from the FCC as well as the Justice Department. However, a merger of the third and fourth largest wireless carriers may not evoke regulatory skepticism of a similar kind.
T-Mobile has recently shown signs of turning the corner, with back-to-back quarters of subscriber gains after nearly four years of sustained losses. In the last quarter, the carrier added 2.4 million subscribers, twice as many as the other major carriers combined (though that was driven by a subscriber loss at Sprint). This can attributed to the company’s aggressive "Uncarrier" campaign and its deal with Apple (NASDAQ:AAPL) to carry the iPhone last year. T-Mobile has also raced ahead of Sprint in LTE coverage despite beginning its network deployment much later, which has accelerated Sprint’s postpaid losses in recent quarters. With T-Mobile regaining its footing, antitrust authorities may see the deal as Sprint’s attempt to take out a competitor that is starting to be disruptive to its plans.
Complexity In Network Integration
Although the deal appears to be a simple joining of forces between the third and fourth largest wireless operators in the country, the technological differences between their networks could make the integration a complex task to conquer. This is likely to be made all the more complicated by the fact that Sprint is currently undertaking an expensive network modernization drive of its own that includes the integration of Clearwire’s (CLWR) spectrum.
Sprint currently provides CDMA/FDD-LTE services on 800 MHz and 1900 MHz spectrum, and is building out a faster TD-LTE network using Clearwire’s 2.5 GHz spectrum. Meanwhile, T-Mobile is using the 1700 MHz AWS band for LTE and 1900 MHz for GSM/HSPA+ services. It is also migrating MetroPCS subscribers from CDMA to its HSPA+ and FDD-LTE networks. The only frequency band that the two carriers have in common is 1900MHz, on which one is running CDMA/FDD-LTE and the other a GSM/HSPA+ network. Acquiring T-Mobile will require Sprint to perform the complicated task of shutting down one of these networks while transitioning subscribers to the other. For the combined LTE network, Sprint will have a tough time deciding what to do with T-Mobile’s AWS band given that it is already investing a lot of resources into building out its 800MHz/1900MHz/2.5GHz LTE network. Carrier aggregation may be the answer, but securing handsets that can access all the different bands could be a tough task.
Disclosure: No positions.