The Sprint and T-Mobile Merger Falls Apart for a Second Time

In 2014, regulatory opposition forced Sprint (S) to give up on its plan to acquire T-Mobile (TMUS 0.19%). Three years later, the two companies returned to the negotiating table, coming close to finalizing an agreement before the deal hit roadblocks once again. What happened? And what lies ahead for the No. 3 and 4 wireless providers?

A full transcript follows the video.

This video was recorded on Nov. 7, 2017.

Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and today is November 7. In this consumer and retail edition of Industry Focus, I have enlisted the help of Fool.com contributor Dan Kline, who is in the studio with me at Fool headquarters. Hey, Dan! It's good to have you, as always!

Dan Kline: Nice to be here!

Shen: Are you in town this time for any special occasion?

Kline: I was speaking to potential college journalists -- well, I guess, they're actual college journalists who want to be professional journalists. I got to give them the scary "our profession is not as good as it was," but there are wonderful places like Motley Fool where, if you can make your way here eventually, it'll be good for you. It was actually organized by a former Fool, as well.

Shen: There you go. Today, Fools, for our main subject of discussion, we're branching out into the telecommunications industry for this episode. You'll have a chance, Dan, to share some of your coverage there. It's been a while since we've talked about this space, but I understand that T-Mobile and Sprint have been making headlines in the past several months, this whole ordeal. Those companies are the No. 3 and No. 4 names, respectively, among U.S. wireless providers. Before we dive into the recent news around their potential merger and how that's fallen through, I want to talk about some of the background for the two companies, and I think that will help once we get into the nitty gritty of the recent news, in terms of understanding some of their motivations and the various incentives that are at play here. 

Let's start with T-Mobile. The company, I think, is probably best known for two things -- its CEO, John Legere, and also its Un-carrier branding, which I think has been very successful for the company.

Kline: And it's not just branding. When John Legere took over, and he's a very bombastic guy, I always likened him to a 1980s pro-wrestling manager. He's very in your face, he'll taunt you, he'll call out his opposition, he has nicknames. Sort of a fun version of what the president likes to do. So what they did with Un-carrier is, he looked at every consumer pain point in the mobile process. So the first big one was contracts. You'd be tied into this two-year contract, you would have a device subsidy, you wouldn't know what you were really paying for anything. They got rid of that.

The more recent ones are having only unlimited data. Yes, I know there's caveats, they slow you down after 22 gigs, but that's 2% of the audience. For most people, completely unlimited data. And every few months, they come out with something new, and it's silly stuff. T-Mobile Tuesday is just like, this Tuesday I get a free Frosty at Wendy's. But last month, they came out with, "We're giving all of our customers Netflix." So they're really trying to find a way to be different, to be a customer first mobile company. And it's worked. T-Mobile has added over a million subscribers for 18 straight quarters. And as John Legere likes to say, they've had all the growth in the wireless space.

Shen: Legere started his role at T-Mobile in late 2012. They rolled out the first Un-carrier Initiative 1.0, they called it at the time, not much later, I believe it was March of 2013. So in that time, as you mentioned, the company has seen some pretty strong results. I think customers and listeners will realize that a lot of the things that they enjoy now, maybe even take for granted when they look through their wireless bill, was often a byproduct of the competition coming from these various Un-carrier moves.

Kline: T-Mobile has forced AT&T and Verizon, and to a lesser extent Sprint, because Sprint wasn't quite as evil as AT&T and Verizon were acting in some of their no-longer practices, but the big one was overages. It's hard to quantify how much we were paying in overages, because they function in two ways. There's the actual, "I go over my data allotment and have to pay." That was billions of dollars. But Legere would always talk about the person who bought a too-big plan, because they didn't want to worry about it, and that was perhaps tens of billions of dollars that was getting sucked out of consumers' pockets. So by being transparent and saying, "We're not going to do those kind of things" -- T-Mobile was No. 4 and sinking, and since 2013, now they're No. 3 and rising. And they've been picking up momentum pretty much every quarter. The challenge is, as Verizon, AT&T, everybody's prices have come down, everybody offers unlimited, Sprint is really cheap, the challenge is, how do you keep doing that when maybe a lot of those pain points are gone?

Shen: Yeah. At the end of 2013, which was, again, the year the Un-carrier program started, T-Mobile had 46 million customers, they had a churn of about 1.7% per month. Now, as of the most recently reported quarter, that's Q3 for 2017, reported just October 23, they have 71 million customers, great growth there. Their churn is down to 1.2%, seeing very consistent progress with that core metric for this industry. Some other notable highlights, from that approximately four-year period, to note, under the leadership of Legere, they moved, as you said, from the No. 4 to the No. 3 U.S. wireless carrier. Of course, that gap --

Kline: It's a huge gap.

Shen: -- is a massive one. So it's really AT&T against Verizon at No. 2 and No. 1, respectively, and then T-Mobile and Sprint at No. 3 and No. 4, respectively. They've had 18 straight quarters of more than one million net customer additions, which I think you mentioned, Dan. They've had compound annual top line growth of almost 14% for that period, improving profitability. T-Mobile shares have gained over 200%, so stockholders are pretty happy with the Un-carrier. 

Let's turn our attention now to Sprint. What have been the big themes or drivers for this company in recent memory? Because they're not doing nearly as well.

Kline: Sprint is doing better, but Sprint was a sinking ship. It was losing ground as T-Mobile was gaining ground, because it had no identity. It was just the carrier that's a little cheaper than AT&T and Verizon, but not quite as cheap as T-Mobile. Marcelo Claure, their CEO, who is willing to go toe-to-toe with John Legere, he sort of righted the ship, but the way he's done it is heavy discounting. So Sprint is almost always, at some point, the best deal. And when I say some point, I mean, maybe it's families this week, maybe it's individuals next week. They're not always the lowest across the board for every type of plan you would want. But they generally have some crazy deal that would be good for somebody. They do things like two iPhones for one.

So they've returned to slight growth in terms of subscribers, but it's not necessarily sustainable, because a lot of their promotions sunset. So March 2018, you no longer pay $30 a month, now you pay $55. And it's so easy to move now, which makes the T-Mobile churn number even more impressive. It's no longer the days where moving was a big challenge and it was hard to get your number. Now, it's very easy. You could switch cellphone providers every three months if you wanted to, it wouldn't be that big of a deal. So Sprint is on better ground, but they haven't spent a lot of money on their network, which is a problem. They will argue that they're within 1% of the other networks, and that's not really what the data shows.

Shen: In terms of the coverage and the network quality.

Kline: Yeah. And the reality is, they're the No. 4 network, generally, on most of the accepted standards. There's all sorts of different data and different ways you can parse things, but it's pretty widely accepted that Sprint is the worst, and it's going to get worse as they don't spend money, which is part of why they might like to be for sale.

Shen: And as of the most recent quarterly report, Sprint has added postpaid subscribers for nine straight quarters. They did see their highest postpaid additions in company history. So some positive marks, as you mentioned. They also cut a ton of costs year to date. I believe it's yielded savings of $750 million.

Kline: It's price, as well, with postpaid. Boost Mobile tends to be the cheapest. So they might be cannibalizing their own customer base, because you can port your Sprint phone to a Boost Mobile phone with zero effort and pay less.

Shen: The cost-cutting efforts are definitely a focus for management right now. They're improving their profitability, but at this point, that company has still reported negative earnings for several years running. And on the not so bright side, the stock is down about 30% year-to-date, and quite a bit today, last I checked before we came into the studio, because the negotiations for this T-Mobile-Sprint deal are officially over. The press release from both companies came out on Saturday. The stock in general has been seesawing between $3 to $10 per share, essentially, for the past five years.

I feel like the cost-cutting and the slowly improving business, or the gradual turnaround that Claure is working on here, it's one part of the puzzle. As you mentioned earlier, the company needs to generate so much cash -- any company in this industry needs to generate so much cash each year to reinvest in the wireless network, to not only just match your competitors in terms of what service you offer, but then you have, for example, 5G networks on the horizon, people already starting to test the infrastructure for that.

Kline: Buying spectrum.

Shen: And that's just another demand in terms of resources that you have to satisfy.

Kline: If you look at what Sprint is doing, they're cleaning up the asset for a sale, a merger, a partnership, whatever it ends up being. We'll talk about that later. But you're not going to make a deal with something that's bleeding customers, that's losing billions of dollars. So if you can take the loss to pretty much zero, and it was a relatively minor loss in the last quarter, and be putting the subscriber needle in the right direction, you're at least showing, whether it's a partner or a buyer or however it comes down, "Hey, there's a bottom here. We're not going to go to zero." And there was a while where it looked like every Sprint customer was just going to become a T-Mobile customer.

Shen: We'll take a closer look at the deal negotiations between the two companies and how that panned out. We'll talk about that next. So now you have some high-level perspective of these two companies, where they are and where they've been the past couple of years. So we can talk about the deal that just wasn't meant to be. It's the second time now, right?

So on Saturday, November 4, Sprint and T-Mobile pushed out the press releases announcing the end of their merger negotiations. Dan, I feel like on this show, we've talked several times about these long, drawn-out ordeals. We've talked about Viacom, their leadership battle, we've talked about the Bass Pro Shops and Cabela's merger being this long, drawn-out saga. And now, we have this last one here. Can you give us a little bit of an idea of how things progressed in the last few months, how they started up and how they ended?

Kline: There are logical reasons for these companies to get together. You put their subscriber bases together, and it's about equal to either AT&T or Verizon. So it gives them scale. You can lay off a lot of customer service people, a lot of accountants.

Shen: Redundant functions, yeah.

Kline: You don't need two networks. There were also some major drawbacks. I didn't want this deal to happen, because I remember when Sprint bought Nextel, when Nextel was essentially No. 5 in the wireless space. Nextel used a different technology than Sprint. As Sprint and T-Mobile are not on the same network technologies. Your Sprint phone can not become a T-Mobile phone. That was the case with the Nextel phone and the Sprint phone. So you're buying something that's not super easy to integrate. It's not like they can just become Spree Mobile, and all of the sudden it's just one company. [laughs] I got one up on you there, we were talking about how this would be named before the show.

Shen: Spree Mobile is pretty good. I was going to go with T-Sprint, but I like this more.

Kline: There were a lot of operational challenges, but the reality on this is, the best deals are when one company wants out. The Cabela's management knew they weren't coming along with the deal. They were all going to cash out, make some money, go fishing or hunting or whatever it is Cabela's management would do. In this case, SoftBank (SFTBF -4.43%), which is the parent company of Sprint, wanted to maintain certain rights and control. They were going to give up the CEO post, John Legere would have that, but they still wanted more management than what they were bringing to the table in terms of valuation offered. That becomes a very dicey deal to make. 

Shen: To be clear, in terms of the parties that have an interest in these deal negotiations, on one side, with T-Mobile, their majority interest stake is held by Deutsche Telekom, about a 65% ownership stake, I believe. And on the opposite side of the negotiation table, you have Sprint, which is over 80% owned by SoftBank and the billionaire Masayoshi Son. He's been a big part of the direction, the vision for Sprint, these various efforts. He actually tried to have Sprint take over T-Mobile back in 2014 --

Kline: When it might have made sense for Sprint. They were still No. 3, they were the bigger company.

Shen: And that deal fell through, because the indication, I believe, that they received from the regulatory body that would overlook and scrutinize the deal was, "This is not going to happen."

Kline: They flat out said, "We will not accept any deal that takes the U.S. market from four providers to three providers." 

Shen: In this case, we have a new administration now, obviously, and I believe that both parties thought they had a situation where regulators might be more friendly to a deal of this nature. Whether that's the case, again, you're going from four to three major players --

Kline: I think the argument they were going to make is that Comcast and Charter are all somewhat in this, or going into this space, with their own wifi-based MVNO networks, which are networks that don't own their spectrum, they lease it from one of the remaining companies.

Shen: Essentially piggybacking off of the companies that have actually developed the infrastructure.

Kline: Yeah. And I think they were going to give caveats that they would license their spectrum to X amount of payers. They were going to argue that there were legitimately more choices for Americans than the three or four or whatever you want to call it. I don't know that that would have flown. But I do think the reality is, there were a lot of reasons this deal shouldn't happen, and once it wasn't quick, I think you knew it wasn't going to happen.

Shen: Then, you mentioned this too, in terms of what the combined entity would look like, 130 million customers, pretty much on par with AT&T and Verizon. They'd have about $75 billion in annual revenue. Definitely a much more formidable player.

Kline: The cost savings would be extraordinary.

Shen: But the integrations, as you said, would not nearly be that simple or that seamless. And if you're a customer with either Sprint or T-Mobile and this deal had come together, it wouldn't have been so quick for you to see improvements in your service, and that just comes from the challenge of combining two huge national networks, but they're on different LTE technology.

Kline: Because there are no contracts anymore, I think there's a very big risk, and I think we saw this with Frontier Communications, which spent $11 billion buying customers from Verizon, and when it didn't very quickly work well, they didn't get billed right, their service didn't work, their internet wasn't good, whatever it was, they just went, "Oh, I'm going to go to Comcast." It's easier to switch your wireless phone than it is to switch your cable service. No one has to come to your house. You can just walk into a Sprint store and they'll give you a bag to mail it back to T-Mobile. It's very simple.

So you could have spent, whatever it is in terms of stock, billions and billions of dollars, to take Sprint's 50 million customers, it's a little bit more than that, but the 71 million at T-Mobile, and you could lose 10% in the first three months. And I think that's what would have happened. Everybody's prices are too close together. You would also have to deal with, the pricing structures are different at Sprint and T-Mobile. Are they all going to go to one? Are they going to stay two separate brands? That doesn't make sense from a pricing perspective. So to me, it always made more sense for either of these brands to partner with a cable company or someone else in an adjacent space.

Shen: And we can get to that idea. You have these two companies, they tried coming together in 2014. At the time, Sprint was the larger player, in more of the power position. Now, the tables have turned, and T-Mobile has more of the leverage. When it comes down to it, SoftBank, what they had in mind for a deal like this, they didn't want to give up too much control of the future of Spree Mobile, as you called it.

Kline: It's also the assets. Masayoshi Son has been spending hundreds of billions of dollars, I forget the exact amount in his tech fund, but it's at least $100 billion. And all of the spectrum assets that Sprint owns, he doesn't want to give up control over, because maybe he'll use it to launch a national over the top cable service. I mean, I'm just making that up, but he wants to be able to pick the company clean for parts. It's not necessarily about the wireless subscribers or that business. I think he was perfectly happy to let John Legere decide what the commercials and the pricing were going to be. It's all the future integration of, does T-Mint or Spree Mobile or whatever we're going to call them, do they merge with Comcast? I think those are the things he wasn't willing to let go. And I think John Legere has earned the right to say, "I don't want to have a boss anymore." And that was going to be a sticking point.

Shen: So differences in terms of what the controlling stake would look like, the ownership between the two companies and their shareholders and this combined entity. And then, also coming down to valuation as well, Sprint's stock took quite a hit in September. I think it went down about 20%. And then, depending on the timing of the deal, it could be that Sprint shareholders didn't see any kind of premium in the merger.

Kline: It's all speculation, because they haven't talked about this, but there have been a lot of reports saying they weren't offering a premium, and it was about efficiency and unlocking value. That's a tough one to sell. But Sprint didn't help itself by, before this negotiation started, they had an exclusive negotiating period with Charter and Comcast about a partnership, a merger. They never exactly announced what it was. But it became pretty clear that there weren't two suitors. So T-Mobile did not have to say, "We'll pay you 40% more," because otherwise, you're going to turn around and, I don't know, McDonald's is going to buy you and use it for mobile ordering. And we'll talk about this soon, there could be somebody out there, but the reason prices drive up in these kinds of deals is, "If you don't buy us, Amazon will." And Sprint is a complicated asset.

Shen: Some other suitor, sure. So let's wrap up our discussion. The deal is no longer happening, off the table as far as we know. These two companies are going to continue to make their investments, operate independently. Let's look at Sprint first. What do you think lies ahead that investors and listeners should be following for this company?

Kline: Well, it won't be McDonald's. [laughs] And, Sprintpotle is also not on the table. Sprint, in my opinion, is going to be sold to a cable company. I think it makes a lot of sense if you're already in the subscription business, you already have that infrastructure for this to be another bundle. I don't think Comcast actually wants to offer a leased service, mostly on wifi, vaguely not that good, nobody wants its phone service.

Shen: Which they recently had with Xfinity Mobile.

Kline: Yeah. And did it, and Altice has now just signed a deal this week to do it using Sprint's lines. I think they're going to want to have a service they can sell nationally. And it may not be a merger, it may be some sort of exclusive partnership with an investment to take some of the pressure off. But they also have all of the spectrum assets, some of which are saleable if they don't need them. So I think that's going to make the most sense, and you just have to see how that industry is going to shake out. Are Charter and Comcast going to merge?

Shen: Do you see it as, Sprint is grooming itself for another suitor to come in?

Kline: Yeah, I think Sprint has to continue to show -- even if they can eke out a profit, it's a lot easier to buy something that's revenue-neutral than buy something that's revenue-negative. If you're going to sell this to Charter shareholders or Comcast shareholders or whoever it is, I think Sprint could do more to cut costs. They could be more of a position to integrate quickly. And that's probably going to mean a lot of discounting, good for consumers, and a lot of barebones staffing, not so good for consumers.

Shen: Let's look at T-Mobile, then. They're still doing incredibly well, claiming a lot of the growth that this industry is seeing overall, no longer combining with Sprint. What are the big next steps for them? Keep going with the Un-carrier initiatives? It seems to be getting harder and harder for them to set themselves apart with that.

Kline: Deutsche Telekom would probably rather not have to keep investing. It's spent like $40 billion in the last six years, or something like that. 

Shen: In terms of the network for T-Mobile.

Kline: In terms of the network and building out capacity. And that's not going to change with 5G and all the other things. So, I think they're open to a deal. I think there's also the possibility that someone like an Altice, a company that's European-based or one of the companies in other parts of the world, that there might be some synergy in either merging with T-Mobile or joint operating, and having a more global company. Again, standards and technology become a challenge there. But I think T-Mobile is in a position where they can sit back, and as long as John Legere doesn't retire, they're in a very good position to just wait for the best deal, see if Amazon or Apple wants to buy them.

Shen: OK. So for both instances, you see some form of consolidation or M&A deal being potential things to watch.

Kline: I don't think it has to be --

Shen: Because, my take was more so for Sprint, for sure.

Kline: The Sprint original deal they talked about was Comcast and Charter was an investment plus, essentially, becoming their wireless company. I think that type of deal is actually more logical for T-Mobile, for a healthy company to say, "Now we're going to offer service in Mexico through Wal-Mart," those types of deals, I think, make more sense with a healthy company than they do with an ailing company. But there is so much negative to owning Sprint that there might be big players like Comcast more willing to have it be an investment in a partnership, rather than an outright purchase.

Shen: Alright. That wraps up our discussion for this deal. We'll continue to track the progress for Sprint's turnaround, for how T-Mobile decides to proceed with their next Un-carrier initiative, for example, as these two companies make those announcements in due time. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening! Thanks for joining us, Dan. Fool on!