- Recent research and press articles support the Sprint – T-Mobile merger, claiming that the consumer would benefit from the arrival of a third major carrier.
- We do not adhere to the analysis that such a merger would spark price cuts for consumers, in view of what has been going on in Europe.
- Anyway, we believe that the long-term pricing environment should be similar in both merger approval and non-approval scenarios. We do not see why the regulator would block the deal.
- The risk/reward is highly attractive: in the worst case, the downside would be limited, while in the best case, the upside would stand around 50%.
Serious calls for a merger approval
In our previous SA article, we said that Sprint (NYSE:S) was an attractive bet given that a merger with T-Mobile (NYSE:TMUS) could overcome regulatory hurdles in view of two main factors. First, competition would not be drastically reduced: the AT&T (NYSE:T) - T-Mobile merger was blocked 3 years ago because AT&T would have reached a dominant position in the U.S. wireless market. But this time around, it's about merging players No. 3 and No. 4, meaning that the combined entity would have 53m postpaid subscribers vs. 97m at Verizon (NYSE:VZ) and 73m at AT&T, and would remain player No. 3. Second, there has been a wave of consolidation in the telecoms-cable-media space recently that could lead regulators to be more open to such a transaction.
Since then, there have been serious calls for merger approval, such as a Bloomberg View article ("Let Sprint Buy T-Mobile") in which the authors explain that "according to a recent study of mobile markets in developed economies by New Street Research, the number of competitors is less important than their ability to compete." And that "allowing them to merge now, before one or both falters, would be more likely to preserve serious competition against the two industry giants."
The European example
This analysis is in line with Sprint Chairman Masayoshi Son's claims that a Sprint - T-Mobile merger will entail significant price cuts for consumers, in a clear attempt to woo the regulator. Price cuts are likely in the early stages of the merger, as the new group will probably seek to show off some commercial momentum. But that could be a different story in the long run.
The European telecoms market, which is ahead in terms of consolidation, and specifically the Austrian market, can be a useful reference to assess the impact of consolidation. The number of major operators in Austria decreased to 3 from 4 last year, following the acquisition of Orange Austria by Hutchinson Austria.
This, combined with an expensive frequency auction marked the end of the price war in the country. Telekom Austria (OTCPK:TKAGY) took the consolidation opportunity to initiate tariff hikes of 10% as soon as Q4 and to raise them a second time in recent weeks, a move followed by T-Mobile Austria, which announced price increases around 20%, on average.
These price hikes came with other pricing and fee initiatives, such as SIM replacement/disconnection fees and a less generous handset subsidy policy (-30% at Telekom Austria).
Such a scenario could apply to the U.S. telecoms market, but to a lesser extent, as the pricing pressures (initiated by T-Mobile) are much lower than in Europe.
In all, the regulator will have to assess the risk of rising prices in two different scenarios:
- In scenario #1, the regulator blocks the merger and takes the risk that one of the two underdogs (Sprint or T-Mobile) falters, leaving only three carriers on the market, including two carriers (AT&T and Verizon) with strong pricing power.
- In scenario #2, the regulator allows the merger, meaning that the number of competitors decreases to 3 (powerful carriers, hence higher competition between them) from 4.
In our view, the pricing environment will be similar in both scenarios. Therefore, we believe that the regulator could allow the merger.
At this point, we reiterate our view that the risk/reward is highly attractive on Sprint: as many analysts and investors doubt that the alleged deal will get regulatory approval, the merger and subsequent synergies are clearly not factored into the current stock price, suggesting very limited downside.
But if the deal goes through, the upside would be huge, i.e. around 50% driven by costs synergies (at least $3bn a year, see our previous article for full details), and potentially above 50%, assuming price increases.
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