Investors seem to be anticipating further consolidation among wireless carriers. Reports suggest Sprint Nextel (NYSE:S) may be considering an offer for T-Mobile US (NASDAQ:TMUS). While a combination between the third and fourth largest U.S. wireless providers might be a good move for those involved, industry giants AT&T (NYSE:T) and Verizon Communications (NYSE:VZ) may end up being the bigger winners.
Does a Sprint/T-Mobile combination make sense?
The wireless provider space looks ripe for deal-making. Industry leaders AT&T and Verizon, each well over three times the size of their next largest competitor in terms of revenue, have a huge competitive advantage due to their scale. The laggards, Sprint and T-Mobile, need to grow in size to offer meaningful long-term competition. So, news that Japanese telecom giant SoftBank, majority owner of Sprint, might be looking to acquire a major stake in T-Mobile shouldn't be a huge surprise. Senior executives at both Sprint and T-Mobile have already gone on record, stating that such a deal would create a "logical ultimate combination" and that three large-sized national wireless companies would provide more industry competition than the current configuration.
While the joining of Sprint and T-Mobile would provide needed competitive scale, it would also be a very cumbersome process. Both companies are already in the midst of large capital-intensive network upgrades, which would increase integration complexity. Sprint is nearly done with a three-year major improvement project, dubbed "Network Vision," which aims to completely renew its 3G network and deploy an improved systemwide 4G LTE service. In addition to that undertaking, the company is also working on how to best deal with its summertime $3.8 billion Clearwire acquisition. Meanwhile, T-Mobile has also been renovating its network. The company has brought a state-of-the-art 4G LTE system into 40 of its top 50 metropolitan areas, while also migrating acquired MetroPCS brand legacy customers onto the service.
The difficulties in aligning and blending Sprint and T-Mobile's operating infrastructure are hard to assess, but the process would assuredly be complicated. Financial stress from the potential merger would likely make a smooth transition even tougher. A company combination, estimated to be funded by around $19 billion in debt, would make the resulting entity highly leveraged. At an intimidating debt-to-sales ratio of near 1.15 times, the united firm might have to consider borrowing pay downs as the top priority.
Reaping the benefit of a complicated combination
AT&T may end up being the biggest beneficiary of a Sprint/T-Mobile union. Without any significant financial stress of its own, having a debt-to-sales level around 0.59 times, the phone giant may feel free to pressure the distracted competition. AT&T is already trying to poach T-Mobile customers with a recent offer of up to $450 per line for switching carriers. Touting its larger and more reliable 4G LTE network, a superior smartphone line-up, and award-winning customer service, AT&T's proclamations will only become more vehement in the midst of a messy Sprint merger.
Rather than making a massive assault on the competition, the company also has the option to sit back and reap the benefits of a consolidated industry. While consumer phone service pricing may not change much, the resulting "big three" wireless carriers will certainly look at reducing cell phone subsidies. These substantial payments to phone makers are a major cause of stifled provider industry profits. AT&T might also view Sprint/T-Mobile turmoil as the chance to make a synergistic acquisition of its own, possibly of a European target, where initial carrier consolidation may be on the horizon.
What about Verizon?
It seems reasonable to assume that Verizon might equally benefit from a Sprint/T-Mobile merger. Verizon has considerable industry clout. It owns the nation's largest 4G LTE network and generated over $39 billion in wireless sales for the first half of 2013 alone. Given the opportunity, this phone behemoth has all the tools necessary to take full advantage of any missteps by Sprint or T-Mobile.
Verizon may have been the best investment candidate in light of industry consolidation, except for its $130 billion buyout of Vodafone Group's stake in the wireless business. Agreeing to pay out at least $59 billion in cash, $60 billion in stock, and other contingent amounts, Verizon now gets full ownership of Verizon Wireless. But, the hefty price tag forced the company to initiate the largest corporate debt offering ever, a $49 billion bond issuance that more than doubled the previous record of $17 billion.
Share dilution and a debt-to-sales ratio around 1.14 times resulting from the Vodafone transaction puts Verizon under some pressure. The firm may have to be more inclined to use its substantial free cash flow for stock buybacks and debt reduction, rather than on taking advantage of a Sprint merger.
Further industry consolidation among wireless carriers appears likely, and a Sprint/T-Mobile merger seems logical. But, the possible combination will not be an easy endeavor. If the deal can surmount governmental antitrust concerns, integration issues may end up presenting competitors like AT&T and Verizon an opportunity to expand their market share. Once definitive news about a Sprint/T-Mobile union hits the headlines, longer-term investors may want to consider AT&T as one of the best ways to play continued wireless industry consolidation.
Profit from the smartphone revolution
Want to get in on the smartphone phenomenon? Truth be told, one company sits at the crossroads of smartphone technology as we know it. It's not your typical household name, either. In fact, you've probably never even heard of it! But it stands to reap massive profits NO MATTER WHO ultimately wins the smartphone war. To find out what it is, click here to access the "One Stock You Must Buy Before the iPhone-Android War Escalates Any Further..."
Bob Chandler has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.