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AT&T to Acquire T-Mobile USA for $39b

Regulatory Hurdles Sure to be High

Well, I told you less than two weeks ago that Sprint (NYSE:S) wasn’t likely to acquire T-Mobile USA, for a variety of reasons, but I certainly didn’t foresee Sunday’s news that AT&T (NYSE:T) would step up to the plate!  Back in the mid-2000s it was often speculated that AT&T would merge with Deutsche Telekom (“DT”)-owned T-Mobile USA, primarily because of their compatible technology bases, but at the time, AT&T apparently didn’t think it needed the fourth largest U.S. wireless carrier…How times have changed!

AT&T and DT issued a press release Sunday afternoon outlining the financial details of the $39b transaction:  AT&T will pay approximately $39b in stock and cash, $25b in cash, for T-Mobile USA.  Based on Friday’s closing price of just under $28/share, AT&T will issue roughly 500m new shares; no T-Mobile debt will be assumed.  J.P. Morgan has made an 18-month commitment to provide AT&T with a $20b, one year unsecured bridge term facility.  The agreement has been approved by the Boards of both companies.

The joint press release also waxes optimistically about the many benefits the combination will bring about, for the companies, their shareholders, consumers and even the folks in Washington: 

“This transaction represents a major commitment to strengthen and expand critical infrastructure for our nation’s future,” said Randall Stephenson, AT&T chairman and ceo. “It will improve network quality, and it will bring advanced LTE capabilities to more than 294m people. Mobile broadband networks drive economic opportunity everywhere, and they enable the expanding high-tech ecosystem that includes device makers, cloud and content providers, app developers, customers, and more. During the past few years, America’s high-tech industry has delivered innovation at unprecedented speed, and this combination will accelerate its continued growth.”

Stephenson continued, “This transaction delivers significant customer, shareowner and public benefits that are available at this level only from the combination of these two companies with complementary network technologies, spectrum positions and operations. We are confident in our ability to execute a seamless integration, and with additional spectrum and network capabilities, we can better meet our customers’ current demands, build for the future and help achieve the President’s goals for a high-speed, wirelessly connected America.”

Deutsche Telekom chairman and ceo René Obermann said, “After evaluating strategic options for T-Mobile USA, I am confident that AT&T is the best partner for our customers, shareholders and the mobile broadband ecosystem. Our common network technology makes this a logical combination and provides an efficient path to gaining the spectrum and network assets needed to provide T-Mobile customers with 4G LTE and the best devices. Also, the transaction returns significant value to Deutsche Telekom shareholders and allows us to retain exposure to the U.S. market.”  DT will have a roughly 8% ownership stake in AT&T following the deal, and appoint one board member.

The announcement raises a plethora of issues that will certainly be discussed and debated for the next year or so as AT&T works to get approvals.  First and surely foremost is the antitrust review; it remains highly speculative to assume this deal sails through.  The FCC and other industry watchdogs have already noted that the wireless industry has devolved into a powerful duopoly and we’ve also been writing on the topic here in our blog.  Expect heated debate and ultimately, should approval be granted, major concessions (read divestitures) on the part of AT&T.  That said, AT&T has agreed to a particularly hefty breakup fee to DT/T-Mobile should the deal not go through, including a $3b cash payment as well as the transfer of unspecified spectrum licenses.  I interpret this to mean that AT&T thinks it can get the deal done.

Beyond that obvious first point, there are many, many issues that this news raises:  What does it mean for spectrum auctions down the road? What will the impact be on consumer prices and for the T-Mobile subscribers who chose the carrier for its low-cost options?  What happens with AT&T’s pending Qualcomm spectrum buy, which has already been strongly contested, largely by rural wireless operators and proponents?  How will Verizon (NYSE:VZ) respond, if at all?  Can a combined AT&T/T-Mobile compete with the runaway train that is Verizon Wireless?  And so on…We’ll be writing on the proposed AT&T/T-Mobile combination for weeks and months ahead and plan to provide, in particular, analysis relevant to our largely rural telco subscriber base.

Here I want to provide our initial take on the valuation implications for the deal.  I suggested that DT wouldn’t sell T-Mobile USA to Sprint, largely because Sprint doesn’t really need T-Mobile, at least not at a price DT would have accepted.  DT was carrying the T-Mobile equity on the books at more than $20b and there’s another $16b in debt, for a implied enterprise value of nearly $37b.  Running a discounted future income model, and using the cost of debt and equity I assumed for Sprint, I couldn’t get the value of T-Mobile anywhere near that.

But when you run the same projected cash flow streams in the model with AT&T’s cost of capital, it’s not hard at all to achieve the $39b valuation.  AT&T’s cost of debt is 5% or less; in order to reach the $39b value one needs only assume a 7% cost of equity, which for AT&T isn’t unreasonable (or is it? Another question we'll explore).  That also doesn’t factor in the $40b in synergies that AT&T believes it can achieve over time.  (We’ll have more to say on that point too…does combining two struggling entities really make for one that’s stronger? Maybe…)

The multiples themselves demonstrate two things:  first, T-Mobile, despite it’s flashy “Largest 4G Network” ad campaign, has been falling further and further behind the pack.  It was the only top wireless provider to lose subscribers in the fourth quarter; Verizon’s the leading provider, AT&T WAS the only one with the iPhone, and Sprint has effected a solid turnaround since Dan Hesse took over in 2008. 

T-Mobile has done a good job of holding revenue and cash flow steady, given its subscriber trends, but it has been counting more and more on prepaid and wholesale subscriber growth—which are less profitable.  Furthermore, T-Mobile’s spectrum disadvantage has been widely analyzed and we’ve known it was exploring all options:  Clearwire (Nasdaq:CLWR) spectrum, a LightSquared resale deal, the aforementioned Sprint possibility as well as the D-block auction for 700 MHz spectrum (which may or may not happen now).  At the end of the day, combining with AT&T certainly makes the most sense for T-Mobile and parent DT—IF it can pass regulatory muster.  This is still a huge question in my mind…

At 1.8x revenue and about 7.1x cash flow, the valuation multiples come in well below those of the last big round of wireless deals.  Back in 2007 through late-2008 AT&T and Verizon were paying 3x revenue or more for rural fill-in acquisitions.  Verizon’s Alltel buy was done right at about 3x revenue, but it spent 4.5x revenue for Rural Cellular, which presumably saved it a lot in roaming.  AT&T paid 3.7x revenue for Dobson, another rural fill-in buy.

The T-Mobile deal isn’t so much about rural fill-in as it is about spectrum and the savings that will come by combining the network assets and eliminating jobs and marketing budgets.  As for DT accepting the offer, clearly no other player was willing or able to offer what AT&T can pay, and having the 8% ownership of AT&T allows DT to say it still has a U.S. presence—something the company has always touted as a positive given the higher ARPUs and data usage in the U.S. versus Europe.  Only time will tell, however, if that 8% ownership stake delivers good returns or not…personally, I’d rather be Vodafone (Nasdaq:VOD), with its 45% stake in Verizon Wireless, than DT with an 8% stake in AT&T…of course, $25b in cash is nothing to sneeze at either.

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