On Tuesday, October 2, rumors that Deutsche Telekom (OTCQX:DTEGY) is negotiating the merger of its T-Mobile USA division with MetroPCS Communications (PCS) sent shares of PCS surging upward about 17.8 percent, while pressuring shares of Sprint Nextel (NYSE:S) to fall about 5.4 percent, and about 11 percent in two days. On Wednesday morning, Deutsche Telekom, announced the companies had approved a merger to combine the U.S. wireless businesses into one company, where Deutsche Telekom will hold a majority stake.
Deutsche Telekom's T-Mobile USA is the fourth-largest U.S. carrier and is seeking to stop client losses and increase scale to more effectively compete in a market that is still dominated by AT&T (NYSE:T) and Verizon Wireless, the mobile joint venture between Verizon Communications (NYSE:VZ) and Vodafone Group (NASDAQ:VOD). Sprint stands as a distant third behind the two giants, and would still be the third largest even if T-Mobile USA and MetroPCS were to merge in a manner that loses none of its subscribers. Nonetheless, such a merger would be notably absent one of the primary reasons that both Deutsche Telekom and MetroPCS have been losing market share: not having a contract with Apple (NASDAQ:AAPL) for the iPhone.
Last year, Sprint attempted to acquire MetroPCS, but during Q1 of 2012 the company announced that its board had decided against the deal. This current deal would limit Sprint's apparent options regarding making a targeted acquisition in the near term. Some investors must have believed Sprint would return to discussions with MetroPCS or entertain M&A talks with Deutsche Telekom. Though the deal does not preclude Sprint from merging with T-Mobile USA, it would likely push off any such discussions until the merger is completed, and increase the price paid.
Sprint itself may be a warning to Deutsche Telekom that this merger could be dangerous. In 2005, Sprint acquired the then formidable Nextel Communications for $36 billion, or over twice Sprint's present market valuation. In the wake of that deal, Sprint spent billions more to amalgamate the incompatible networks. Shortly thereafter, due to the iPhone, Sprint Nextel began to sustain a significant decline in market share as subscribers defected. Subscriber defections continued until Sprint contracted with Apple for the iPhone late in 2011. Sprint also inevitably gave up on the Nextel network and is still ramping it down.
Sprint had held discussions with Deutsche Telekom about buying T-Mobile USA before the March 2011 announcement that AT&T offered to acquire the unit for $39 billion. Sprint ended up opposing that deal and subsequent U.S. regulatory scrutiny forced AT&T to abandon its bid for T-Mobile USA. Since that deal fell apart, the telecom industry has been anticipating that T-Mobile USA would find some other smaller party to merge with or acquire outright.
While the deal would bring more customers, airwaves and geographic reach, T-Mobile would remain a distant fourth in the U.S. market, trailing Verizon Wireless, AT&T and Sprint, in first to third order. T-Mobile is also behind in investing in the latest wireless technology, long-term evolution or LTE. T-Mobile USA may be forced to phase out MetroPCS' network, much like Sprint is still doing with Nextel.
Since obtaining the iPhone, Sprint has been able to somewhat right its business model, and the equity performance has dramatically improved. Within 2012, Sprint shares have more than doubled, largely because of the ability to maintain and grow a subscriber base due to the iPhone. Shares of the larger VZ and T have also performed well in 2012, growing by about 14.66 percent and 25.89 percent, respectively. Both have performed better than Deutsche Telekom, though a portion of DTEGY's underperformance is clearly due to its larger European business. Similarly, Vodafone has underperformed these other telecom equities within 2012. See a 2012-to-date equity performance comparison chart, below:
After the AT&T acquisition of T-Mobile USA fell apart, the company had to do something. Through the last two years, T-Mobile lost approximately 10 percent of its subscriber base, or over 2.75 million customers. MetroPCS is a pay-as-you-go carrier, which means its customers do not have long-term contracts. Prepaid users are often young and/or with poor credit, making them less appealing customers than a contract customer.
Without a contract, their potential fore a customer to defect to another network is far greater, raising a question as to whether MetroPCS' customers are the best ones for T-Mobile USA to acquire. The move appears to be part of T-Mobile USA's ongoing strategy to compete against its larger opponents a more affordable alternative. Nonetheless, without the iPhone, its chances of future success are likely heavily linked to the future of the iPhone, where continued demand for it will result in more customer losses. If the iPhone begins to lose steam, though, T-Mobile USA will be fortunate to be absent the heavy subsidization costs associated with a carrier's acquiring the iPhone. Either way, chances are that there will be more acquisitions amongst the smaller domestic mobile carriers.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.