After failed sale, T-Mobile returns as buyer

Contact: Ben Kolada, Thejeswi Venkatesh

After failing to sell its T-Mobile USA subsidiary last year to AT&T for $39bn, Deutsche Telekom has pivoted from trying to exit the T-Mobile business to pushing it even deeper into the US market. The company announced on Wednesday that T-Mobile USA has reached a merger agreement with low-cost competitor MetroPCS in an intricately structured deal.

MetroPCS’s shareholders will receive $1.5bn in cash and 26% of the combined company. While that looks straightforward at first glance, the deal is structured as a reverse acquisition.

MetroPCS will pay its shareholders $1.5bn in cash (it ended the second quarter with $2.3bn in its treasury) and halve the number of shares outstanding by performing a 1-2 reverse stock split. MetroPCS will then acquire all of T-Mobile’s stock in exchange for a 74% stake in the combined company, leaving MetroPCS’s shareholders with a 26% holding. Though MetroPCS is technically the surviving entity, it will assume the T-Mobile name and will continue to trade publicly in the US.

The combined company is projecting 2012 pro forma combined revenue of just shy of $25bn. For comparison, the US’s third-largest cellular provider, Sprint, is expected to put up about $35bn in sales this year.

A bit of irony here is that analysts expected that the previously planned AT&T-T-Mobile merger would reduce competition and increase prices. However, in announcing their merger, T-Mobile and MetroPCS repeatedly claimed that the combined company would be a ‘value-focused’ provider – a pretty way of saying that it would be a low-cost carrier.

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AT&T does Sprint a favor

Contact: Ben Kolada

If the rumors that Sprint was eyeing T-Mobile USA were actually true, then AT&T did its competitor a big favor by taking in the divested business. From our view, T-Mobile would have been a bigger bite, both financially and operationally, than Sprint could have swallowed. The transaction would likely have introduced a whole new set of tricky integration problems just at a time when Sprint is (finally) emerging from the set of problems it took on when it did its last big deal, the $39bn purchase of Nextel in late 2004. (Sprint shares have lost 80% of their value since that ill-fated acquisition.)

Sprint is already the only national carrier managing three different networks (CDMA, iDEN and WiMax), and the addition of T-Mobile would have added a fourth, bringing additional cost and complexity to the carrier’s operations. And while Sprint is moving back into the black, T-Mobile’s financial performance wouldn’t necessarily have helped that effort. (Don’t forget that the Deutsche Telekom subsidiary has long been a laggard, in terms of margins and subscriber growth, and is being divested for less than it was acquired.) While Sprint is adding subscribers and is finally growing revenue (2010 marked the first time in four years that it grew its top line), subscriber and revenue growth at T-Mobile have been flat.

Instead of T-Mobile, several of the remaining cellular properties in the US would fit better, both technologically and financially, with Sprint. While Sprint’s share price plummeted on AT&T’s news, stocks of regional cellular carriers such as MetroPCS and Leap Wireless soared on buyout speculation. Like Sprint, both are CDMA network operators, and both would provide Sprint with growing revenue and subscriber bases. And both companies are still within Sprint’s price range.

Even with M&A speculation inflating their valuations, MetroPCS and Leap currently sport $5.5bn and $1.1bn market caps, respectively. A cash-and-stock deal similar to AT&T’s T-Mobile acquisition could actually put both under Sprint’s ownership, since Sprint is sitting on $5.5bn in cash and short-term investments. And Sprint actually seems the most likely acquirer for these companies, even though Verizon is widely speculated to react to AT&T’s announcement with a deal of its own. Given the scrutiny that AT&T’s pending purchase of T-Mobile is expected to receive, we doubt that Verizon, currently the nation’s largest cellular carrier, could make a deal without regulators saying they’ve had enough.

Ma Bell’s mobile move

Contact: Brenon Daly

In the largest US telco deal in a half-decade, AT&T will hand over $39bn in cash and stock for T-Mobile USA. Assuming it goes through, the combination would create the country’s largest wireless provider, with some 130 million subscribers. The consolidation move, which has been a hallmark of AT&T over the past decade, would give the carrier one-third more wireless subscribers than second-place Verizon and more than twice the number of Sprint.

Clearly conscious of its increased market share, AT&T took a number of steps – both in language and in terms – to blunt criticism and concerns over the concentration. For instance, in its release AT&T tosses a sop to regulators by portraying this move as a step to connecting ‘every part of America to the digital age’ – a quote borrowed from President Obama and backed by the Federal Communications Commission. (The FCC and the US Department of Justice will likely cast a sharp eye on the planned deal, which AT&T hopes to close in a year or so.) And, in an effort to shore up populist support, AT&T highlights in its release that it is the only major wireless carrier to be a union shop. We can’t remember the last time a major acquirer trumpeted its union status in an M&A release.

Aside from the spin in the official release, the terms of the proposed transaction also appear to us to be structured with an eye toward knocking down as much uncertainty as possible. For instance, AT&T collared the $14bn in stock that it is set to give to T-Mobile USA’s parent Deutsche Telekom. (Although, at least based on Wall Street’s initial reaction, that wasn’t necessary as investors actually nudged the Dow component 1% higher.) But what really caught our eye was the stiff breakup fee: if AT&T has to walk away from the deal, it will be on the hook for a $3bn payment, as well as have to transfer an undefined chuck of spectrum to its would-be partner. That’s a lot of incentive to get it closed.