T-Mobile Should Put That Breakup Fee To Good Use

Includes: DTEGY, S, T, VZ
by: Zvi Bar

On Monday, December 19, 2011, AT&T (NYSE:T) announced that it was dropping its bid to acquire T-Mobile USA, a subsidiary of Deutsche Telekom (OTCQX:DTEGY), for $39 billion. The U.S. Department of Justice filed suit to prevent AT&T from acquiring T-Mobile, sounding in concerns that that the combination of the second and fourth ranked U.S. mobile service providers may stifle competition and raise consumer prices.

AT&T will have to pay Deutsche Telekom $4 billion for dropping the acquisition. T-Mobile's owners were apparently well aware of the significant potential for the deal to fail, and wisely included this significant break-up fee, which is akin a to about a 10% non-refundable deposit on the proposed purchase. AT&T stated that it will pay $3 billion in cash and pay the balance in wireless spectrum, and that the payment will be recorded in Q4 of 2011.

The first and third largest providers are Verizon (NYSE:VZ) and Sprint (NYSE:S), respectively. Various consumer groups and Sprint opposed the merger at the onset, though unions broadly approved it. AT&T claimed that the proposed M&A activity would provide better service to a larger area, by combining the networks and their mobile spectrum, and consolidating both behemoths' future development costs.

The DOJ appeared wholly concerned that T-Mobile USA was too important of a market competitor, whose absence would lessen pressure to keep profit margins low and/or improve service. According to DOJ Deputy Attorney General James Cole the lawsuit sought "to ensure that everyone can continue to receive the benefits of that competition." Further, Sharis Pozen, acting assistant attorney general for the DOJ's antitrust team added, "consumers in the wireless marketplace would have faced higher prices and reduced innovation. We sued to protect consumers who rely on competition in this important industry. With the parties' abandonment, we achieved that result."

AT&T was once the only U.S. telephone company, known as Ma Bell, and it was split into many parts due to antitrust issues. The resulting "Baby Bells" eventually began to consolidate. Two of the larger regional Bells, Southwestern Bell and BellSouth, created a wireless network that was first called Cellular One, and which was later re-named Cingular. Eventually, and after both acquired other Baby Bells, Southwestern Bell and BellSouth merged together and also with AT&T, whose name they kept. Verizon was created by Bell Atlantic, another major Bell, which changed its name to Verizon after merging with GTE.

Competition to the Bells came in many forms, but most were acquired. GTE and MCI were both acquired by Verizon. Sprint was initially a competitor to AT&T's long distance business but has since transformed into a mobile service business, much like the Bells did, and even sold off its land-line business. Sprint also purchased another former major competitor, Nextel.

All of these mergers and acquisitions have resulted in the current landscape, from which AT&T attempted to buy its way out of the number two position and past the industry leader, Verizon. The DOJ has apparently had enough buying by the big telecoms, now believing these businesses are fully saturated and not paying particular concern for any single company's present costs to compete. Nonetheless, Deutsche Telekom had previously expressed the desire to leave the U.S. market, which it deems slow-growth, and a reluctance to invest in continuously building higher-speed data networks for the market.

The end of this deal will be felt by many investment banks, including JPMorgan Chase (NYSE:JPM), which advised AT&T, and Morgan Stanley (NYSE:MS), which advised Deutsche Telekom along with Citigroup (NYSE:C), Credit Suisse and Deutsche Bank (NYSE:DB). It was estimated that M&A advisory fees would total around $150 million, and such fees are generally not paid unless deals are completed. As such, any work done on this project by these banks may have been a waste of their time.

Richard Rosen, a Washington-based partner at Arnold & Porter LLP, advised AT&T on this attempted deal. Mr. Rosen is a former DOJ official that represented AT&T in its absorption of Cingular Wireless and several other deals. T-Mobile hired George Cary, a Washington-based partner at Cleary Gottlieb Steen & Hamilton LLP. Mr. Cary represented Time Warner in its merger with AOL and SmithKline Beecham in its merger with GlaxoWellcome.

Unlike the investment banks, attorneys advising M&A will likely keep their legal fees. Mr. Cary should also likely get a nice bonus or holiday present from T-Mobile for securing such a sizable failure to complete fee. Some individuals may question whether Arnold & Porter deserves its legal fees for advising AT&T to propose a deal that appeared so likely to face significant opposition from competitors and the government. In particular, this sizable fee for failure to complete the deal appears to be a costly option or deposit.

One must wonder as to the precise advice AT&T was provided regarding this fee and the likelihood of the deal's success, and whether the firm will continue to be AT&T's go-to option for M&A advice. It is possible that AT&T was fully advised of the risks and still felt eager to propose the deal out of desperation and a general acceptrance of the high cost of doing wireless telecom business. Earlier this month, Arnold & Porter announced it will combine with Howard Rice Nemerovski Canady Falk & Rabkin PC, an 82-lawyer San Francisco-based firm, before the end of 2011.

The cost involved in developing these ever improving networks is a considerable barrier to entry by new competitors and a considerable cost to present competitors. By now subsidizing T-Mobile with this break-up fee, the number four mobile service provider may now have the funds needed to continue competing within the U.S. and build a newer network. Additionally, due to its smaller stature, T-Mobile should be able to make use of that money to acquire a smaller competitor and potentially fortify its position or even move up to the number three spot.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is intended to be informative and should not be construed as personalized advice as it does not take into account your specific situation or objectives.