By Jack Fuller
AT&T’s (T) shock announcement of purchasing T-Mobile last month sent Wall Street into a frenzy, immediately changing the wireless landscape and prompting investigations by regulators. The dust has finally started to settle following the announcement, and the potential merger has us wondering what other potential synergies exist between other carriers. Some possibilities: A Verizon (VZ)-Sprint (S) merger, Verizon-U.S. Cellular (USM) merger, Sprint-Leap (LEAP) merger, or a Sprint-MetroPCS (PCS) merger.
AT&T Inc.: We’ve all seen Verizon’s advertising campaigns highlighting the weakness of AT&T’s network (“the map,” anyone?). AT&T faced major spectrum issues from an overloaded iPhone (AAPL) user base; by acquiring T-Mobile, AT&T would immediately relieve some stress on its overtaxed network while improving its financial health and negotiation leverage. AT&T’s lawyers have reportedly been devising strategies to tackle regulators’ concerns for some time now, and this deal looks like it has a good chance of going through. The AT&T - T-Mobile merger would be a major coup for AT&T on all fronts, and would make it the largest carrier in the U.S. by a wide margin. Shares trade at $30.29 at the time of this writing.
Verizon Communications Inc.: Besides Sprint, Verizon may be most surprised by the potential AT&T - T-Mobile merger. Verizon seemed like it was headed for open waters: It held the #1 spot in the wireless industry, its network was consistently rated better than AT&T’s, it enjoyed phenomenal success with the launch of its Droid line of phones, and the addition of the iPhone meant that it had the opportunity to steal a substantial amount of subscribers from AT&T’s user base. Imagine Verizon’s shock when it heard that it would soon be the #2 player in the field.
If the AT&T and T-Mobile deal goes through, Verizon won’t rest on its laurels for long. Two possible targets for a deal: Sprint and U.S. Cellular. A Verizon/Sprint merger would yield 23% more customers than AT&T - T-Mobile, smaller than the gap between AT&T - T-Mobile and Verizon as it stands now. The deal would allow Verizon to maintain the spectrum advantage and negotiation leverage it currently enjoys. However, if the AT&T - T-Mobile deal goes through, regulators likely wouldn’t approve further large-scale consolidation. We think Verizon faces greater possibility of acquiring U.S. Cellular (see below). Verizon trades at $37.71.
U.S. Cellular: With 6.2 million customers, the country’s sixth-largest wireless provider is finding it increasingly difficult to find its competitive niche. USM can’t compete with AT&T or Verizon in terms of coverage and phone line-up, and has also had to deal with pricing pressure from Leap Wireless, MetroPCS, and T-Mobile’s pre-paid phones. Approval of an AT&T - T-Mobile merger would take one of USM’s major price competitors out of the equation and could help future profitability, but we still believe USM adds greater value as an acquisition target than a standalone company. Approval of AT&T’s purchase of T-Mobile means regulators would likely have to approve a deal for a Verizon/U.S. Cellular merger. The deal would help close the subscriber gap between AT&T - T-Mobile and Verizon, while giving Verizon some added spectrum to boot. Share prices have increased dramatically to $48.96 since mid-March with M&A rumors surrounding the company.
Vodafone Group PLC ADR (VOD): The second-largest phone company in the world sold its 44% stake in French mobile phone company SFR to Vivendi (OTC:VIVDY) for $11.4 billion, well above the $9.7 billion maximum Vivendi would reportedly pay. The deal values SFR at 6.5 times its EBITDA earnings last year, a major coup considering Citigroup (C) analysts report that Vodafone sold its stake to Vivendi at a 24% premium. Vodafone recently offloaded stakes in Softbank (OTCPK:SFTBF) and China Mobile Limited (CHL) for a combined $12 billion, leaving one major uncertainty in its portfolio – its 45% holding in Verizon.
The two companies have had a history of disagreement, including Verizon’s refusal to pay a dividend to Vodafone in 2006 in an attempt to force Vodafone out. Rumors swirled at the time of a merger between Verizon and Vodafone (could you imagine the juggernaut a Vodafone/Verizon merger would create?) but Vodafone held off, a status that won’t change anytime soon. Rumors may have crept up again about a Verizon and Vodafone merger, but we don’t see this one happening with the companies’ past relationship and the regulatory scrutiny a Verizon/Vodafone merger would come under. Vodafone trades at $28.91.
Leap Wireless International Inc.: Leap operates two mobile brands, Cricket and Jump, that provide phones and data services to 5 million customers across the US. The value provider competes directly with MetroPCS, and has fallen behind a bit after MetroPCS changed its pricing strategy and experienced two consecutive quarters of operational outperformance. Leap followed suit by changing its pricing plan and introducing stronger handsets, and the efforts should lead to higher average revenue per user. Along with USM and MetroPCS, Leap could be a winner from the AT&T - T-Mobile merger. AT&T’s purchase of T-Mobile removes a major player from the pre-paid phone market, giving Leap additional growth prospects, and M&A rumors have sent the stock price soaring. Leap already has a 3G data roaming deal in place with Sprint, and a logical next step could be an outright Sprint/Leap merger. If we use the $154 enterprise value per subscriber valuation Sprint used to buy Virgin Mobile’s (VM) subscribers last fall, Leap’s subscribers would be worth $800 million. In reality, Leap users generate more revenue with larger margins, and would be worth considerably more. We’re not sure if this one will happen, but it’s a possibility we can’t ignore. Leap trades at $16.34.
MetroPCS Communications Inc.: MetroPCS maintains a subscriber base of 8.1 million users as of December 2010, and was the first mobile operator to commercially launch 4G LTE services in the US. Like Leap and U.S. Cellular, MetroPCS doesn’t have any sustainable competitive advantages compared to larger wireless networks, and will probably find more value as a takeover target. However, compared to Leap, MetroPCS has been making gains in the pre-paid and bargain department with new pricing plans that have attracted new customers and revenue. MetroPCS and Leap discussed a merger as recently as 2007, but Leap’s 3G data roaming deal with Sprint has taken the wind out of those merger talks. The company most likely to take over MetroPCS would then be Sprint. Before news of the AT&T - T-Mobile merger broke in February, rumors swirled that MetroPCS was looking for a buyer, with Sprint possibly interested. Sprint’s deal with Leap may have paved the way for a Sprint/Leap merger instead, but a merger between Sprint and MetroPCS remains a deal we think could be very possible. MetroPCS trades at $16.60.
Sprint Nextel Corporation: If there is one clear loser in the AT&T - T-Mobile deal, it’s Sprint. Before news of the merger broke, Sprint and T-Mobile had allegedly held direct talks over their own merger, but that obviously isn’t an option anymore. The news also hurts Sprint on the negotiation front. Sprint already found it difficult to gain negotiating leverage compared to the two larger carriers (Sprint has a subscriber base of nearly 50 million, compared to Verizon’s 94.1 million and AT&T’s 86 million), and the possibility of a merger with T-Mobile helped increase its negotiation leverage with other players. Factor in that subsidies on smart phones are already sapping margins and hurting profitability, and Sprint’s future outlook looks glum.
The only advantage Sprint could take out of the deal is that it becomes the only other major alternative to the big two, and the primary provider of value pricing-plans. However, that strategy would leave it at a huge cost disadvantage compared to AT&T and Verizon, and may not be sustainable in the long run. Sprint shares trade at $4.96.