Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) have been eyeing each other for years, believing that a combined company would be a more viable competitor to larger rivals Verizon Communications (NYSE:VZ) and AT&T (NYSE:T). There's been considerable speculation and back-and-forth, with the companies announcing last November that they had officially "ceased talks to merge as the companies were unable to find mutually agreeable terms." That statement was intended to "put an end to the extensive speculation around a transaction."

Last night, T-Mobile and Sprint announced that they have finally agreed to merge, following rumors earlier this month that the talks were back on.

John Legere holding out his hand while speaking on stage

T-Mobile CEO John Legere. Image source: T-Mobile.

It's an all-stock deal

The transaction is structured as an all-stock deal with a fixed exchange ratio of 0.10256 shares of T-Mobile for each Sprint share, or 9.75 Sprint shares for each T-Mobile share. That pegs Sprint's enterprise value at $59 billion, which would value the combined company at $146 billion. The combined company will go by T-Mobile, which has significantly strengthened its brand in recent years under CEO John Legere, who will lead the new entity. 

T-Mobile and Sprint estimate that they can generate annual cost synergies of $6 billion, while the new company would also benefit from a combined spectrum portfolio and greater network scale. The companies say the combined company will employ more people and create thousands of jobs in the U.S., which is peculiar since megamergers typically involve significant layoffs to realize those cost synergies.

The combined company would be able to accelerate 5G innovation more rapidly than either company could do separately, T-Mobile and Sprint argue.

The market is already skeptical

Shares of both companies have dropped following the announcement, which is the opposite reaction that you would normally expect with M&A news. But this isn't a normal situation, as investors have long known that any potential deal would face intense scrutiny from antitrust regulators. The Department of Justice is currently trying to block AT&T's own proposed acquisition of Time Warner, for instance.

The national market for wireless service would go from four main players to three, with a combined T-Mobile/Sprint having approximately 126.2 million total wireless subscribers. That subscriber base would still lag Verizon (150.5 million) and AT&T (141.6 million), according to estimates from Strategy Analytics. The figures include both retail and wholesale connections (Verizon does not disclose wholesale connections).

There is a considerable risk that regulators would attempt to block the deal, which is why it's good that there is no breakup fee associated with that possibility.

Four carriers, HHI scores, and seven years ago

It's worth remembering some of the context when regulators blocked AT&T's proposed acquisition of T-Mobile back in 2011. Regulators calculate the Herfindahl-Hirschman Index (HHI) as a way to measure market concentration when evaluating these types of deals. HHI is measured on a scale of 0 to 10,000 and is derived by squaring the market shares of all companies and then summing the results. A low HHI shows that there is plenty of competition, while a high HHI suggests there is very little competition and is likely to get pushback from regulators.

Here's how the DoJ views different HHI levels, according to its horizontal merger guidelines (last updated in August 2010). 

HHI

Level of Market Concentration

0 to 1,500

Unconcentrated

1,500 to 2,500

Moderately concentrated

2,500 and above

Highly concentrated

Data source: Department of Justice.

In the 2011 case against AT&T and T-Mobile, regulators calculated that the HHI for the national market for wireless service would increase by nearly 700 points to over 3,100. For the enterprise and government subset of the market, the HHI would have been over 3,400. While the market shares that served as the HHI inputs seven years ago have likely changed somewhat, there's a very good chance that the HHI will still be above 2,500 for this proposed megamerger.

The odds that this deal goes through aren't great. BTIG analyst Walt Piecyk estimates the probability of regulatory approval at under 40%. It looks like the market is pricing those chances in accordingly.