Verizon Could Be Looking To Compete With - Or Buy Out - MetroPCS

Includes: T, TMUS, VZ
by: Erik Gholtoghian

There are five major phone companies in the US, and though a merger is possible in the industry, it will not happen among these largest firms. You see, AT&T (NYSE:T) made a major blunder when it bid on T-Mobile in the first place. It was well known at the time of the bid that the merger would have resulted in too much market power, therefore the government would block the deal.

To me, this means either AT&T's management is the most incompetent in the country and just lost millions of dollars of time and expenses for the shareholders by making an elementary economics mistake, or AT&T had a plan to buy off the government with lobbyists in some way.

Whatever the case, onlookers should have been fully aware that the deal was extremely unlikely to go through from the start. But what deal might be allowed?

The only deal that might be allowed is a merger which involves MetroPCS (the smallest of the big phone companies), because its merger will result in the least market power being created in the industry, and could be tolerated.

This means Verizon (NYSE:VZ), AT&T, Sprint (NYSE:S), or even T-Mobile should be looking to acquire MetroPCS (PCS). And especially of late, MetroPCS has been extremely attractive due to its firm foothold over the low-end market. But assuming one of the companies wanted to buy MetroPCS, the first thing to do would be make MetroPCS appear to have less market power. This could be accomplished by lowering prices and targeting MetroPCS customers. Once a dent is made in MetroPCS profits, the larger companies stand to be able to buy MetroPCS at a much cheaper price than would otherwise be the case.

Meaning, if MetroPCS totally dominates the low-end market, any bidder on the company is going to have to pay a huge premium to get the company. But if there is significant competition with MetroPCS at the low end, it gives the illusion that MetroPCS isn't as valuable as before, making a much lower bid more likely to be accepted. T-mobile recently dropped prices, but didn't come down that close to MetroPCS prices.

Today Verizon announced a $50 all-you-can-use plan using prepaid, low-end messaging phones to compete head to head with MetroPCS. They could have done this long, long ago, but they waited until today. Why? Because the T-mobile AT&T merger is now almost certainly going to be blocked. This means Verizon is secretly making plans to make an acquisition of its own, because there is some room for one merger in the industry.

The most logical choices are, of course, those the government will allow, and which focus on the low-end market, because Verizon already dominates the high end. Verizon could become much more highly diversified if it picked up MetroPCS. LEAP Wireless is another choice, but Verizon should try and buy the company which has the most market power that the government will actually allow. It is a certainty that the government would allow a Verizon purchase of LEAP, but the government very likely would allow a MetroPCS merger as well.

In conclusion, MetroPCS is the only company of the big 5 phone companies which has a chance to be acquired due to high market power concentration in the industry. Verizon controls the high end of the market better than all other companies, which means it would benefit more than the other companies by acquiring MetroPCS and its low-end market customer base.

The pricing move that Verizon made today gives some slight evidence that management may be now trying to influence MetroPCS, most likely in an attempt to manipulate its revenues for a period of time prior to a merger offer. The last thing the companies competing with MetroPCS want is a price war, because they know they will lose that battle. MetroPCS has been extremely profitable during a period of time which saw all other companies losing customers and usually losing money. And, at this very same time, MetroPCS did the brilliant thing by completely avoiding the capital expenditures necessary to rollout a 3G network, and instead investing for the future when there might actually be some competition.

So what does that mean about MetroPCS? It means it can offer a 4G network in an all-you-can-use plan for only $50 per month using high-quality, Android-based smartphones (more arriving monthly). And this is while the best any Big 5 competitor can do is offer garbage phones for $50 per month.

The final point is that with such healthy profits and growth, not only is MetroPCS in the driver's seat right now, it will be in the future. And if other companies dare strike up a pricing war, MetroPCS can offer 4G unlimited plans on Android-based LTE phones for $40 per month. MetroPCS is a valuable acquisition target indeed. So valuable that it just may not be acquired and taken over unless Verizon acts quickly.

The most glaring fundamental statistic that demonstrates how much MetroPCS would help Verizon is to look at the 5-year expected PEG ratios. VZ is overvalued at 1.82 while MetroPCS is cheap at 0.44. A purchase would add value to Verizon, and it would create diversification among revenues and eliminate competition at the same time.

Disclosure: I am long PCS.