The telecom industry is becoming more price competitive after the recent resurgence of T-Mobile (NASDAQ:TMUS). The telecom giant has made a comeback thanks to its LTE rollout, price reduction strategy, and the breakup fee and spectrum it received as a result of the failed acquisition attempt by AT&T (NYSE:T).
Sprint (NYSE:S) has been recently suffering due to a steady decline of subscribers. In the wake of these developments, Softbank, which acquired Sprint recently, has offered to buy T-Mobile. Deutsche Telekom, a 67% interest holder, agreed. The perception is that the deal is highly unlikely due to the Federal Communication Commission's, or FCC's, concerns that such a deal would deter competition and affect consumers adversely.
The deal and its implications
SoftBank is seeking growth in new markets and Deutsche is expected to focus on home markets and enhance its operations in eastern Europe. T-Mobile is valued at around $28 billion, and Sprint has agreed to pay $40 per share, which translates to a valuation of more than $32 billion. The bid seems to be low as the synergy gains alone can be in excess of $20 billion as noted by an analyst at J.P. Morgan. Deutsche Telekom is expected to keep a 15% to 20% stake in the combined company. Negotiations regarding the financing and termination fee, should the move get blocked, are still pending.
The merger will allow T-Mobile and Sprint to consolidate their networks. The new entity will have extended coverage and, more importantly, a mix of high and low band spectrum will help in offering higher data speeds with consistent coverage. The point is that the duopoly of Verizon and AT&T will be challenged and the large players will be forced to reduce prices. However, there may be another outcome. The merger will result in three large players, each having a subscriber base of around 100 million. A silent understanding may leave all the companies content with their subscriber share and enable them to charge higher rates.
The telecom industry is already undergoing a round of consolidation with the potential mergers between AT&T/DirecTV and Comcast/Time Warner. News of the Sprint/T-Mobile merger will force the FCC to scrutinize all these deals. If one of them is blocked then it is likely that all will face the same fate, or it could be the other way round. The FCC may not allow such a deal due to the concerns mentioned above but Softbank's CEO is arguing that Verizon and AT&T are a duopoly and they charge much higher rates for a speed that is lower than that in Japan.
He further claims that T-Mobile or Sprint cannot compete with the big guns on their own, but together they can foster constructive competition. This argument indicates that Softbank is looking to follow a cost leadership strategy. However, the FCC may have to redefine the rules for the spectrum auction next year if it approves this deal. The current rules allocate lower band spectrum for smaller players like Sprint and T-Mobile, which will be the key to improving competition in the U.S. market.
T-Mobile investors look set to benefit regardless of the merger's outcome. A tie-up will increase the amount of consideration received for the stock and in case the deal falls through, T-Mobile may get a breakup fee which will strengthen its balance sheet and improve its valuation.
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Muhammad Saeed 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.