The shares of MetroPCS Communications Inc. (PCS) jumped almost 18% on the news of a possible merger with Deutsche Telekom's (OTCQX:DTEGY) T-Mobile yesterday, and it has recently been confirmed that the respective boards of both companies have approved the merger. Today, the stock fell by 9%. Under the terms of the deal, PCS will make 1 for 2 reverse stock split, and make a payment of $1.5 billion in cash to its shareholders.
According to Reuters both DTEG and PCS want to list the combined entity on the stock exchange post-merger, giving DTEG a 74% stake in the combined entity, with the remaining stake belonging to PCS. Moreover, the German company has also agreed to provide the merged company with a $500 million credit facility. The transaction, which is expected to be concluded in the first half of next year, is subject to regulatory approval; however, it is unlikely that it will face too much resistance considering the deal wouldn't lead to excessive concentration of power, as the combined entity will still not have a market share greater than Sprint (NYSE:S), the third largest U.S. telecom operator.
This deal can be looked at positively in a number of ways. T-Mobile is the fourth-largest telecom carrier operating in the U.S. in terms of number of subscribers, and as at the end of second quarter, 2012, it had a total of 33.2 million subscribers, out of which 21.3 million were postpaid subscribers. PCS, which only caters to the prepaid segment of the market, ended the second quarter with 9.29 million customers. With both companies combining, the merged enterprise will definitely become a stronger competitor to other operators, while still lagging behind them in terms of subscriber numbers.
The combined company will also gain more airwaves and a wider LTE network to provide more coverage and high speed to its customers. Even though PCS has lost customers to bigger rivals Verizon (NYSE:VZ) and AT&T (NYSE:T) due to their greater market coverage and customer demand for high speed 4G services, PCS customer cancellations are on the decline, and more and more customers are switching to its 4G services. Moreover, competition among telecom carriers in terms of various plans and services on offer has become fierce over time, and both T-mobile and PCS have done well to compete with their bigger rivals. In fact, both PCS and T-Mobile are currently offering the cheapest 4G data plans, which include services like no contract requirement, unlimited data, text and voice, which can bring customer growth going forward.
Apart from operational benefits, both companies are expecting significant financial benefits as well. According to the press release, the company is expecting to generate a 5-year revenue CAGR of somewhere between 3%-to-5% as well as free cash flow growth of 15%-to-20%. Cost synergies of $6 billion-to-$7 billion are also expected from the deal, on top of the synergies expected from revenue growth. Moreover, the combined company will also have direct access to the debt and equity markets in the U.S., giving it further financial flexibility.
Overall, we believe the merger between T-Mobile and PCS will bring substantial synergies as the network capital expenditures requirements might be reduced. Moreover, the combined company will gain operational scale in terms of wider network coverage, wider range of handsets, as well as new territories to offer its cheaper unlimited plans. And as far as the telecom industry consolidation is concerned, this will certainly help increase the combined market share of the two companies, enabling them to become stronger rivals to larger companies like Sprint and Verizon.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Qineqt's Telecom Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.