Verizon (VZ) and AT&T (T) have often been regarded as a duopoly in the US telecom market. This may not be very far from the truth considering Verizon has a market share of 39% while AT&T boasts of 30%.
But some deep pocketed, foreign telecom companies are about to change all that with their acquisitions of U.S. telecoms. Deutsche Telekom (OTC:DTEGF) acquired Metro PCS (PCS) and plans to merge it with its T-Mobile operations. Japanese company Softbank (SFTBF.PK) made a $20.5 billion splash by acquiring U.S. telecom Sprint (S).
View from Verizon
In response to a pointed question on the developments at Sprint and T-Mobile by an analyst during the company's conference call, Verizon EVP and CFO Fran Shammo said Verizon anticipated and suspected some consolidation, but instead viewed the foreign investments as a sign of the strength of the U.S. market and its growth potential.
He pointed to Verizon's advanced stage 4G LTE network that had more coverage than all competitors taken together - perhaps meaning that the company had a very substantial early mover advantage in this new and hot mobile technology.
Shammo also referred to one of Verizon's most valuable resources - its high-quality, contiguous 700 MHz spectrum across the United States, the launch pad for the new 4G LTE network. Not to mention the closing of the $ 3.9 billion AWS spectrum deal with cable companies, albeit subject to conditions.
Lastly, and probably the clincher, Shammo said Verizon has been spending on an average $ 10 billion annually on its wireless and the wireline IT backbone support for that wireless network, and though the market has been sometimes critical on the size of this capital expenditure, the quarter's results are validation of the resulting execution. What was left unsaid was that newcomers would face the daunting prospect of a very huge investment to bring their networks on par with Verizon's.
Summing it: a head start in 4G LTE, choice spectrum bank and a massive investment in telecom infrastructure that has come of age and is pushing up profitability in the recent quarters.
Softbank chief Masayoshi Son's agenda is well-known. With the Sprint acquisition, he's obviously trying to engineer an encore of his success in turning around Vodafone Japan, which too rose like a Phoenix to challenge a duopoly that held 80% of the Japanese mobile market. In swift moves that employed aggressive marketing and cutthroat pricing, and acquired the iPhone franchise for Japan, Softbank quickly rose to the top of the heap in Japan in terms of subscriber adds.
"When two rich firms rule the market like a duopoly, we see this as a real opportunity for a challenger," says Son.
The deal to acquire Sprint is engineered in a way that leaves Sprint with $8 billion in cash on its balance sheet. In recent times, Sprint has been hamstrung in its efforts to expand its networks due to the high component of debt on its books. The backing of Softbank, plus the cash, should help Sprint to raise financing on better terms. The combined size of Softbank-Sprint could also enable the procurement of equipment and handsets on more lucrative terms.
Yet, there is no denying that Sprint faces a huge backlog in LTE rollout compared to Verizon. And Verizon's numbers clear point to a rising consumer preference for LTE: Sales of 4G LTE smartphones were up 50% and 35% of Verizon's data traffic is already onto 4G networks; moreover 16.5% of its post-paid subscribers have migrated to 4G. Clearly the way to go! By the year-end, Sprint plans to have 123 million POPs, AT&T 150 million POPs and Verizon 260 million.
Son has been reported to say that aggressive pricing combined with aggressive investment in the "best technology" can work even though the market is controlled by two huge rivals.
But, look at the odds. Verizon reported free cash flow of $13.443 billion during the nine months ended September, and gross debt of $10 billion, cash of $ 8.1 billion and a net debt of only $1.9 billion.
Contrast this with Sprint: free cash flow to September was a mere $1.4 billion, and net debt stood at $13.4 billion. It has a looming commitment to purchase iPhones worth $15.5 billion, and has been consistently loss-making.
Analysts had questioned Verizon's wisdom in pulling the plug on unlimited subscriber plans. Verizon instead shifted focus to its "Share Everything" plans that encouraged consumers to connect multiple devices. Surprisingly the move appears to be paying off, judging by the Verizon's Q3 results. On the other hand, Sprint is placing a lot of reliance on the attraction of its unlimited plans as a key differentiator. Could it be behind the curve? According to analysts, unlimited plans would be highly attractive to LTE users because of the high speed - but this factor could play in Sprint's favor only once its entire LTE rollout is complete by the end of next year.
Deutsche Telekom - T-Mobile - MetroPCS
Earlier this month Deutsche Telecom agreed on a $ 1.5 billion deal that will lead to a reverse merger between Metro PCS and Deutsche Telecom's US arm, T-Mobile. The combined entity would have 40 million subscribers, and will be the fourth largest carrier in the US.
Given the two companies use different frequencies on the networks, the technological marriage could be rocky, but Metro PCS intends to provide LTE connectivity to all subscribers by the end of the year, and this could lay the base for more subscriber additions in future years.
Yet, this merger is also said to be a means to allow Deutsche Telekom to exit from the USA gradually, perhaps by selling its shareholding in a phased manner. It may be recalled that the AT&T and T-Mobile deal could not pass the regulators.
Given this agenda of Deutsche Telekom, it is unlikely that the merged entity could be having Verizon in its sights, as of now. Besides, regulatory approvals could take until the middle of next year.
Verizon appears to be holding all the cards as of now, and a few more quarters of sustained profitability and subscriber additions, while the smaller rivals are grappling with regulators and merger tribulations, should make its lead unassailable.