Entries in AT&T:T (29)

Monday
Dec262011

The Deal is Dead! Now What?

AT&T and T-Mobile Consider Life Post Deal

After enduring nine months of an increasingly hostile regulatory review, AT&T finally threw in the towel and announced it would abandon its efforts to acquire T-Mobile USA.  Back on March 20, 2011, AT&T announced that it planned to acquire T-Mobile in a transaction valued at $39b.  Although there was plenty of opposition to the deal from the very start, most analysts nonetheless expected the deal to pass muster with the Department of Justice and the Federal Communications Commission, provided, that is, AT&T agreed to sell off large swaths of overlapping spectrum and operations.

In fact, word was that AT&T was ready to sell Leap Wireless spectrum and nearly 25% of T-Mobile’s U.S. subscriber base in an effort to gain regulatory approvals.

But the deal started to spiral south in late August when the DOJ filed suit to block the merger.  When, in late November, the FCC concluded that the deal would cause price increases and harm customers, all that was left was for the Fat Lady to sing.  Stick a fork in it, the deal was dead!

Now we begin the healing process and both AT&T and Deutsche Telekom, T-Mobile’s German parent, have gaping wounds to lick.  AT&T is saddled with what has been estimated to be a $6b deal break-up fee.  In addition to the two carriers entering a seven-year roaming agreement, the package requires AT&T to pay T-Mobile $3b in cash as well as spectrum in markets including Los Angeles, Dallas and Boston.

AT&T ceo Randall Stephenson is probably feeling a little vulnerable now that the deal has been killed.  It’s tough enough that Stephenson had to follow in the shadow of former AT&T ceo Ed Whitacre, who transformed the smallest of the Baby Bells, Southwestern Bell, into AT&T through a string of successful blockbuster deals – the culmination of which was the acquisition of AT&T.  Now Stephenson is faced with having to cut a $3b check to T-Mobile and is left with a core operation whose 4G wireless strategy has suffered a major setback while its principal competitor, Verizon Wireless, appears to be lapping the pack. 

Despite the setback, AT&T vows to continue to invest in its networks and encourages the government to free up additional spectrum.  With respect to investing in its network, AT&T will need to work quickly to meet the build-out requirements associated with the $6.6b worth of mostly B-block 700 MHz licenses it acquired during Auction 73 back in early 2008.  B-block licenses must provide service covering 35% of its geographical area by February 2013.   

Regarding spectrum, and perhaps as in a gesture of goodwill following a brutal past nine months, the FCC approved AT&T’s previously announced $1.9b acquisition of D- and E-block 700 MHz licenses from Qualcomm just two days after AT&T officially quit the T-Mobile deal.  The Qualcomm deal gives AT&T as much as 16 MHz of new 700 MHz spectrum and should help the carrier assemble the 20 MHz of contiguous spectrum necessary to provide robust 4G services in many markets.  But it is highly likely that AT&T will once again be shaking the trees for available spectrum, particularly 700 MHz spectrum.

As bad as things seem for AT&T, they’re probably even worse for T-Mobile.  Yes, T-Mobile ceo Philipp Humm will get $3b of cash and some pretty nice wireless licenses to soothe the pain but at the end of the day the spectrum-poor T-Mobile has some serious strategic issues.  There is plenty of speculation that T-Mobile will rekindle talks with Dan Hesse and Sprint.  Reportedly, Sprint and T-Mobile were close to a deal earlier in the year before AT&T threw a wad of cash at Deutsche Telekom.  In fact, just a few days before AT&T announced that it had come to a $39b agreement to acquire T-Mobile, the Wall Street Journal was reporting that Sprint and T-Mobile were closing in on a deal.  Other options for T-Mobile include acquiring Leap Wireless or doing a data deal with Clearwire.  There is even talk that T-Mobile might team up with DISH Networks, which finds itself with a bunch of spectrum in search of a wireless strategy after its acquisitions of DBSD North American and Terrestar Satellite Network. Interestingly, there is also an increasing buzz that AT&T may itself be making a run at DISH.

But it wasn’t just AT&T, T-Mobile and Deutsche Telekom who lost out on the deal.  According to reports, there were seven banks lined up to receive $150m of fees if the deal closed.  No deal means scaled back Holiday plans for a number of “poor” Wall Streeters!

Wednesday
Nov232011

FCC Calls for Hearing on AT&T / T-Mobile Combo

This Deal is Doomed

Eight months after the surprise Sunday announcement that AT&T intended to acquire T-Mobile USA, and three months after the Department of Justice filed a lawsuit against the proposed deal, FCC Chairman Julius Genachowski revealed Tuesday that he opposes the combination. The Chairman circulated a draft Hearing Designation Order (HDO) amongst the other FCC Commissioners which effectively says that the FCC finds the proposed combination not to be in the public interest.

Assuming the HDO is approved by the other Commissioners, a hearing will be scheduled (not before the DOJ’s lawsuit) wherein an administrative judge will consider the facts. According to a note issued by the Rural Telecommunications Group (RTG) last night, the last time the FCC issued an HDO was when DirecTV and DISH Network were trying to merge; the DBS concerns walked away from that deal rather than fight the inevitable.

In my mind the failure of AT&T and T-Mobile’s efforts to merge has been inevitable all along, but especially following the August 31 filing of the DOJ’s lawsuit (never mind similar moves by Sprint and other opponents); the FCC’s action yesterday just confirms my long-held suspicions.  An AT&T spokesperson called the move “Disappointing…”  

Disappointing sure, but surprising?  No way, although clearly AT&T believed it could push the merger through when it announced the deal last March.  My initial response back then was:

“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.” 

Despite AT&T’s vehement denials that thousands of American jobs would be lost and its promise to bring 5,000 overseas call center positions back home, there’s simply no way that the company could achieve the touted synergies without eliminating a massive number of T-Mobile jobs.  Back in June, my colleague David Selzer analyzed the composition of the $40b in long-term synergies that AT&T told investors it expected and concluded that a HUGE number—as many as 30,000—of jobs would be eliminated in the long run:

“The fact is that a merger like the one contemplated in this case will require a significant work force reduction to achieve AT&T’s publically predicted synergy value…Notice that the NPV of the non-headcount related synergies creates only about $19b in value, which is a hefty sum for sure, but is a far cry from $40b…Factoring in a workforce reduction of just under 85% of the T-Mobile employee base, based on my assumptions, provides about $900m in annual cash savings and another $7.8b in NPV. Combining these figures gets you annual savings in the $3b range and provides a total net present value of nearly $27b. This seems reasonable given that our calculations do not include the value of synergies generated in the first two years of operation after the deal closes, or any spectrum related synergies.”

Basically, Dave’s math concluded that it simply wouldn’t be possible to create that much in synergy value without firing the bulk of T-Mobile’s staff.

But the most obvious reason why I’ve been sure that this deal wouldn’t pass antitrust scrutiny is the fact that AT&T and Verizon Wireless already account for the vast majority of the wireless industry in the United States at this time, and are taking more and more subscribers from smaller competitors each quarter. In the third quarter of this year, AT&T added more net new subscribers than even Verizon Wireless; my analysis of the top wireless providers showed that AT&T and Verizon grabbed more than half of both gross and net adds in the period…and as we noted last summer, “Between 2006 and 2009 the combined share of net subscriber additions for AT&T and Verizon Wireless rose from 59% to 92%…and over the four years analyzed, the top-two carriers accounted for 71% of total net additions. Figures like these speak for themselves.”

The fat lady is about to sing. AT&T may decide to stubbornly fight in court or just walk away (after handing over substantial cash and spectrum to T-Mobile), but either way the deal is doomed. As a consolation prize, however, the FCC did indicate yesterday that it will support AT&T’s pending $1.9b buy of 700 MHz spectrum from Qualcomm.

As far as I’m concerned, Randall Stephenson and other AT&T execs need to seriously consider just walking away from T-Mobile as they consume tomorrow’s turkey. Take the $33b that’s left after paying T-Mobile’s breakup fee and deploy LTE as quickly as possible! How many markets does Verizon Wireless now serve with LTE (including this analyst’s home town)? Oh that’s right…179. And how many does AT&T serve now? 9. Time’s a wastin’. 

Thursday
Jun022011

Clearwire Urged to Sell Spectrum

Letter to Ceo Stanton Highlights Clearwire’s Missteps--But Imminent Spectrum Sale Seems Unlikely

Private investment firm Pardus Capital issued a press release last week disclosing the content of a letter sent to Clearwire (Nasdaq:CLWR) interim ceo and chairman of the board John Stanton wherein Pardus president/ ceo Karim Samii outlined in detail Pardus’ concerns that Clearwire is increasingly up against the ropes when it comes to its efforts to raise funding for its business plan, as well as in regards to its negotiating leverage with 54% owner Sprint (NYSE:S).

The letter raises numerous valid points, but the most pertinent one in my mind is the question of who has the upper hand between Sprint and Clearwire today.  Clearly Sprint believes that it does—and it may be right, for now anyway, although I’m not fully convinced. And despite Pardus' many arguments for a "small spectrum sale" now, I don't see it happening in the near-term.

Sprint’s Network Vision plan to reconfigure its network over the next several years will decommission its Nextel/iDEN network and repurpose the spectrum and network assets for CDMA service; presumably there is also a path-to-LTE element in the planning which would reduce Sprint’s reliance upon the Clearwire WiMax network. But the project is expected to last for three to five years and that’s an eternity in the wireless marketplace.  Without Clearwire and pre-Network Vision completion, Sprint doesn’t HAVE a 4G strategy.  Meanwhile, Verizon (NYSE:VZ) introduced a handset for its LTE 4G network in mid-March and reported 250k sales of the device in just two weeks before the quarter ended. 

Customers—the high-value ones anyway—want 4G services.  AT&T (NYSE:T) doesn’t have it, MetroPCS (NYSE:PCS) has it in just a few markets and others, most notably Leap Wireless (Nasdaq:LEAP), are looking to LightSquared to provide it.  At this point, however, I see LightSquared as a red herring.  Not only because the pure wholesale business model has never succeeded before, but because it now says it might lean on AT&T for early LTE capacity, because the interference issues it has with global positioning services (GPS) have not been resolved, because its capacity will be limited as a result of that interference and because, “Service will be available in the second half of this year,” is the most detail I’ve seen on the actual buildout…LightSquared is reportedly now in talks with Sprint too…it’s all getting very incestuous but the fact is, for now anyway, the only up and running 4G networks with measurable coverage are Clearwire’s and Verizon’s.

Which brings me to subscriber growth.  Sprint has turned its sub growth around admirably compared with the serious losses it was experiencing a few years back.  But if you look at the detail of Sprint’s most recent quarter, of the 1.1m in net adds, they were ALL either prepaid subs (not likely to be heavy spenders or data users) or they were added by Sprint’s wholesale partners and affiliates.  On the postpaid, retail side of the business, Sprint lost 114k customers.  Obviously the Verizon iPhone and AT&T’s competitive response had an impact on its ability to retain high-value postpaid customers.

Now take a look at Clearwire’s results in the same quarter.  The company added 1.6m new wholesale subscribers—those are essentially all Sprint customers.  My interpretation of these data points would be that Clearwire’s 1.6m new wholesale customers are 1.6m customers who would have moved from Sprint to Verizon if the 4G product that Sprint offers—over Clearwire’s network—wasn’t available.  Had that happened, Sprint would have been reporting a loss of half a million subscribers, even with the prepaid growth. Yes, this is probably an oversimplification, but the point is, I think Sprint needs that 4G network, for its marketing and for its status as a carrier and to ensure that its entire subscriber base isn’t comprised of $28/month prepaid subscribers in a few years.

Clearwire on the other hand, has a different set of woes.  First, it’s gone out and invested billions in a next-generation wireless data network that runs on a technology that increasingly appears to be the Betamax of 4G wireless data technology. 

Now it’s nearly run out of money, has had to suspend its retail strategy and is scrambling to cover costs, while Daddy (Sprint) has refused to up its allowance.  In fact, it cut the allowance if you buy into Pardus’ argument that the new wholesale agreement came in 30% low:

“The market also took as a negative the ultimate resolution of the Sprint pricing dispute.  We expected the deal would yield around a penny per megahertz for Clearwire. It appears to have come in closer to $0.007/MHz. Another way to look at it: instead of yielding $7.60 per in-market subscribers in more mature markets, Clearwire should be making $10.00 per sub. The market took this as a “sweetheart” deal for Sprint.”

Clearwire’s failure to sell excess spectrum last fall, before T-Mobile was taken out of the picture as a potential buyer, means that it has an even smaller potential buyer pool today, which translates generally to lower values, despite the widely espoused view that the country is heading for a major spectrum crunch.  And herein lies Clearwire’s biggest problem with regards to an immediate spectrum sale.

As Pardus Capital points out in its letter to Stanton, Clearwire’s current equity value implies a value per MHz POP of less than $0.20.  Assuming that some value should be assigned to the subscriber base and network assets (admittedly fairly low), the implied public spectrum value falls even further.

Clearwire’s spectrum is comprised of 2.5 GHz BRS/EBS licenses, which does not have the attractive propagation characteristics of lower band spectrum like 700 MHz.  But it has  a LOT of it; the company’s 10-K reports 46 billion MHz POPs and more than 150 MHz in top markets.  Its deployed network covers 70 markets nationwide, or about 130m POPs.

Of interest regarding BRS/EBS spectrum is a recent FCC release where the Commission asks for comments on proposed changes to the out-of-band emission limits for BRS/EBS service.  Proponents, including Clearwire, have suggested that the change would allow WiMax-based networks to use channel bandwidths of 20 MHz rather than the 10 MHz used today, and Clearwire suggests that it would then be able to deliver data speeds of 90 Mbps, which it cannot do today. Satellite concern Globalstar has opposed the proposal saying that it would result in interference with its service, but other engineering studies refute that claim.  The FCC is taking comments on the matter but it seems clear to me that should the out-of-band emission limits be raised, the relative value of Clearwire’s spectrum holdings would rise--yet another possible reason to wait for a sale. 

At the end of the day, Clearwire remains challenged in many respects, but so too does Sprint.  And the spectrum assets Clearwire holds, assuming it can keep its head above the water, could, in my opinion, be worth a little more than Wall Street is acknowledging.  That’s Pardus Capital’s opinion too, though the investment firm is clearly losing patience.

But John Stanton didn’t become a wireless billionaire simply by virtue of being in the right place at the right time.  As he pointed out on the company’s last earnings call, “Every time a kid downloads a video onto his phone or a company arranges for a video conference call via their iPads, you're in effect seeing the value of spectrum rise. And I think that it would be prudent for us to be in a position to hold that spectrum, all the spectrum, even that which is beyond what we immediately need.”  I tend to agree. As long as Sprint continues to load the Clearwire network with customers, the company should have enough cash flow to survive this year and on into a period where its excess spectrum assets may be more highly coveted.

Friday
May272011

Sprint Waging War Against AT&T/T-Mobile Combination

State Level Investigations and Excerpts from Dan Hesse's Senate Subcommittee Testimony

I have written here before that I see AT&T’s proposed buy of T-Mobile as a negative, not only for the industry and competition, but frankly, for AT&T and T-Mobile.  From where I stand, the two companies serve fairly different primary constituencies and many, many T-Mobile subscribers are likely to flee once faced with the higher prices that AT&T will eventually demand.  In my mind, this could potentially be a good thing for more price competitive carriers, primarily Sprint (NYSE:S), Leap Wireless (Cricket, Nasdaq:LEAP) and MetroPCS (NYSE:PCS).

Clearly, however, Sprint ceo Dan Hesse and his posse don’t view it quite the way I do…over the past two weeks, Hesse has testified before the Senate Judiciary Subcommittee on Antitrust, Competition Policy and Consumer Rights, and the company has begun to take its campaign to the state level.  Meanwhile, literally thousands of individuals have filed comments against the deal with the FCC (I searched Sprint’s web site to see if it has a button for people to click right through and file their opposition, but so far didn’t find anything).

While it isn’t really clear whether or not states will have any jurisdiction in the matter, California's PUC announced yesterday that it will open an investigation into the merger.  Sprint has also formally asked Louisiana and West Virginia to look into the matter; Louisiana said a week ago that it would accept public comments.

In reading Dan Hesse’s comments before the Senate subcommittee, I found several comments worth repeating...We've heard many of these arguments before--we've made several of them ourselves. It seems now the question becomes political, with Republicans tending to support the merger and Democrats opposed. 

Excerpts from Dan Hesse's Testimony Before the Senate Subcommittee on Antitrust, Competition Policy and Consumer Rights:

“If…the DOJ and FCC decide to permit the takeover, the wireless industry would regress toward a 1980s-style duopoly. AT&T would become the largest wireless carrier in the country with over 94 million subscribers and approximately 43% of the post-paid market. Coupled with Verizon's over 83 million subscribers and 38% of the post-paid market, the scope and scale of the resulting duopoly, controlling more than 80% of all U.S. contract customers and approximately 80% of all wireless industry revenues, percentages that would likely grow each year after that, would be prohibitive to viable competition from other carriers…This merger would put Humpty Dumpty back together again, and it should be stopped.”

“…[W]ireless communications is a fundamental platform for our entire economy. For example, in 2010 the wireless industry accounted for nearly $160 billion in revenue, approximately $25 billion in capital expenditures, and employed, directly or indirectly, an estimated 3.6 million Americans. If the industry remains competitive, wireless devices and services could generate productivity gains over the next 10 years amounting to almost $860 billion in additional GDP.”

The Wireless Industry and America

“The Mobile Age has arrived. It took 100 years to build one billion fixed phone lines, but only 20 years to add five billion mobile subscribers. At the end of 2010, over 302 million wireless subscriptions were active in the United States, a population penetration rate of almost 96%. And for the first time, the U.S. wireless industry last year carried more data traffic (e.g., email, text, and web browsing) than voice traffic. Robust competition in our industry has resulted in steadily dropping prices for higher quality wireless communications services.”

"More American households are abandoning fixed phone lines and looking to wireless exclusively for voice and data communications...Ironically, because of their landline monopolies, AT&T and Verizon have the least incentive to price wireless service competitively enough to stimulate "cord cutting" of fixed phone lines.”

“If the T-Mobile takeover is approved, AT&T and Verizon would control 88% of all wireless industry profits. Consequently, the disparity between the duopolists and all other providers is likely only to worsen. Going forward, it would be difficult for any company to effectively challenge the Twin Bell duopoly.”

"Moreover, as descendants of the Bell monopoly of local wireline telephone companies, AT&T and Verizon each control a vast wireline infrastructure. Among other advantages, this allows them to obtain backhaul - a critical input of wireless service connecting towers to the larger network - at cost. This point cannot be underestimated. While we look at our handsets and the wireless towers they connect to as "wireless", from that point on, wireless traffic travels by landline, over the legacy wireline networks that are largely controlled by AT&T and Verizon. By contrast, because Sprint and other wireless carriers are not owned by large local telephone companies, we are forced to purchase backhaul service, in most cases from our largest competitors - AT&T or Verizon. Whereas Sprint must pay more than $2 billion a year in backhaul fees to its competitors, AT&T and Verizon earn enormous profits from their control over backhaul. By controlling the availability and price of backhaul, AT&T and Verizon are also able, to a large degree, to control their competitors' costs and quality of service.”

“In 1992, the U.S. General Accounting Office issued a report that concluded "duopoly markets are unlikely to provide a product at a competitively set price" and recommended that the FCC grant commercial wireless (Personal Communications Service) licenses to additional entrants because, "by giving consumers an additional choice, the new PCS provider could spur cellular telephone carriers to improve their services and lower their prices." (U.S. GAO, Telecommunications: Concerns About Competition in the Cellular Telephone Services Industry (July 1992) at 41-42.)”

“According to CTIA data, the average monthly billing charge for cellular services dropped from $97 in 1987 to $39 in 1998, and voice revenue per minute dropped from $0.44 in 1993 to $0.05 in 2008.”

“AT&T claims that its acquisition of T-Mobile will give AT&T the additional spectrum it needs and allow AT&T to extend wireless service to some parts of rural America that are without adequate coverage. This is a myth. Even without this transaction, with the Qualcomm spectrum it is purchasing, AT&T has the largest, licensed spectrum holdings of any wireless carrier. But it does not use that spectrum efficiently. Specifically, AT&T is not using on average 40 MHz of its spectrum across the nation - spectrum that could be used to improve service for its customers - but that AT&T has chosen instead to "warehouse" for future services.”

“AT&T could invest in its network to increase its capacity where necessary and use its spectrum more effectively. AT&T does not face a spectrum crisis, but rather a spectrum deployment problem of its own creation. Verizon has less spectrum and more subscribers than AT&T, but just weeks ago Verizon stated publicly that it has sufficient spectrum to meet its needs until 2015. Increasing demand for data-based communications, such as video and internet content, are not unique to AT&T; all carriers have to use their spectrum assignments efficiently.”

“T-Mobile is already heavily using its spectrum in the same high demand areas where AT&T asserts it needs additional capacity. Thus, the proposed merger would bring little spectrum relief to AT&T where it claims to need it the most. If AT&T invested only a fraction of the $39 billion T-Mobile purchase price into its own network, AT&T could alleviate its alleged capacity concerns, upgrade its network, and deploy advanced wireless technologies, without harming wireless competition."

“AT&T also has attempted to justify the T-Mobile takeover by arguing it will enable AT&T to extend wireless services to rural America. This is a false choice. There is nothing in the proposed merger that changes the fundamental economics of rural broadband deployment. Rural areas do not suffer from any shortage of spectrum given the lower demand for services that results from lower population densities. Rather, rural expansion has been delayed because the lack of population density in rural areas simply makes build-out more expensive per subscriber. The addition of the T-Mobile network to that of AT&T would not change this fact, and would only extend the AT&T network to about 1% more of the population than are already in AT&T's network coverage.”

Local and Regional Carriers Cannot Replace T-Mobile

"AT&T argues that there will be adequate competition after its acquisition of T-Mobile by pointing to regional and local competitors, such as niche prepaid carriers, MetroPCS and Cricket. These smaller prepaid companies provide a viable option for a limited group of customers, principally those who want a low cost phone with fewer options and features, and whose usage is primarily in a limited geographic area. However, these smaller prepaid companies will not be able to keep the Twin Bells from raising prices for the vast majority of consumers who want robust wireless device options, a national footprint and continued innovation."

"Importantly, the smaller companies all rely on competitive access to the national carriers' networks for wholesale roaming service, the pricing of which would be controlled by the Twin Bells following the proposed transaction. And for both domestic and international companies that need GSM, with the elimination of T-Mobile, they would now have no alternate nationwide choice."

“As Chairman Kohl noted regarding the proposed MCI WorldCom/Sprint merger in 1999: "One need not be a rocket scientist - or even an antitrust lawyer - to be wary of a merger which results in just two dominant players in an industry." AT&T's takeover of T-Mobile would entrench two dominant players, just as Chairman Kohl cautioned against.”

“If this takeover is allowed, on what pretense would Verizon not be allowed to acquire remaining competitors?”

Monday
Mar212011

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.