There Will Be Volatility: The AT&T / T-Mobile Merger

Mar. 30, 2011 8:19 AM ETAT&T Inc. (T)4 Comments
Andrew Sachais profile picture
Andrew Sachais

In recent weeks, AT&T (NYSE:T) submitted a bid to take over T-Mobile for $39 billion. This has led to mass speculation on both sides, wondering whether the DOJ will step in and block the merger due to antitrust laws or not.

On one side of the coin, those that are for the bid claim that the merger will lead to greater coverage for all Americans throughout the United States. This follows President Obama’s initiative to bring complete coverage to all Americans by 2015. In response to antitrust talk, these pro-merger supporters believe that T-Mobile is not a big player in all local markets, such as Miami and Detroit, where other smaller competitors, like MetroPCS (PCS), hold more subscribers. Based on the competition factor at the local levels, they believe you can’t make the case that this is a horizontal merger of two super firms depleting competition in the industry.

However, those that are against the merger believe that competitive pricing will be wiped out by the sudden existence of a duopoly in the industry, and will inevitably lead to rate hikes. Both sides of the debate are valid, but these are merely perceived effects of the merger. These perceived effects are very narrow-minded and look solely through the spectrum of the consumer. In reality, what the government will review in determining whether to block the merger or not will be based on current law that pertains to the market as a whole, and how we are affected as a country, rather than as strictly consumers.

To begin, the effects of the merger on the employees will be considered. Will this merger lead to job creation or destruction? T-Mobile and AT&T are very similar companies, and they both contain many jobs that seemingly overlap. Not to mention the cell phone industry is currently dominated by four firms; if that number were to drop to three, then jobs become that much more competitive. This will lead to thousands of job cuts; AT&T will cut as many as needed until it has reached its sustainable work force.

The argument for rate hikes is valid as well. As of now, the number of subscribers in the industry is broken down like this: Verizon (VZ), 102 million; AT&T, 95 million; Sprint (S), 50 million; T-Mobile 34 million. After the merger, Verizon and AT&T will dominate the industry based on subscribers. This will create what seems to be a duopoly. At least T-Mobile on its own acted as a low-cost value option for the industry, similar to what Southwest (LUV) did within the airline industry. Once T-Mobile is gone, its subscribers' rates will jump to the higher AT&T prices.

Also, considering the power structure of the industry, it is almost certain that Sprint will struggle to stay afloat and will ultimately go under, given the forecasted conditions. One of the conditions that will hurt the industry is that phone companies will only distribute to the top companies in the industry. Much like what has been seen with iPhone distribution, other companies will follow the leader and companies like Sprint will either be shut out all together or be forced to settle with lesser quality phones.

One of the overlooked effects of the merger will be the poorer quality in the customer service side of the industry. JD Power consistently rewards T-Mobile and Sprint with the honors for excellent service, but once they are eliminated, so too will their quality of customer service.

Considering the potential ramifications, the DOJ is faced with a tough decision. The merger has political backing and promises to create efficiency and keep a competitive environment. People will cite other industries where two companies dominate and there still exists a competitive environment.

The fact is that this is a different industry. Only time will tell if the lack of low-priced competition to undercut the top players will allow competitive prices to remain in this industry as well. Or will the prices settle at an elevated equilibrium that hurts the current consumer instead?

Also, it doesn’t seem that AT&T paid a premium of around 50% for T-Mobile for technological innovation. AT&T and Verizon have enough R&D to create innovation for years to come; AT&T knows the power of reduced competition. Ask anyone, and I am sure they would tell you that the positive effects of a duopoly more than justifies a $39 billion takeover bid.

So what does this mean for AT&T shareholders? If the merger is approved, both Verizon and AT&T will see margins increase and the forecasts will look very attractive. As ROIC grows initially, the share price will grow, and if AT&T can manage to create some growth over that period, the returns will only be magnified. If the merger is denied, then you will see AT&T’s share price take a hit due to the lost potential of what could have been. In either case, taking out a derivative position playing off of the volatility of the eventual decision could lead to good gains.

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

This article was written by

Andrew Sachais profile picture
Author Bio: Andrew Sachais’ focus is on analyzing markets with global macro-based strategies. He is a former hedge fund trader and has written for and was an economist for Minyanville. Sachais takes into consideration global equity, commodity, currency and debt markets, and is a recent graduate of Georgetown University, where he earned a degree in Economics. He currently runs an event-driven macro fund.

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