As growth in the U.S. wireless market plateaued long ago, carriers have been increasingly looking abroad for potential expansion opportunities. This is especially true since pricing power is on the decline, as the big four are currently embroiled in an intense price war, so growth can't come from increasing prices.
With that in mind, it shouldn't have come as a shock when AT&T (NYSE:T) announced on Friday it was acquiring Mexican wireless carrier Iusacell.
Considering the capital intensity associated with international expansion, carriers typically buy their way into new markets as a shortcut. Ma Bell had been looking to grow via an acquisition in Europe last year, and was even reportedly considering making an offer for Vodafone -- even as Vodafone was preparing to sell its stake in Verizon Wireless back to Verizon Communications. Unfortunately for AT&T, the NSA controversy and subsequent skepticism over U.S. tech companies rattled European officials.
AT&T has now turned its ambitions south of the U.S. border in a deal that will create the first North American carrier that covers 400 million U.S. and Mexican consumers and businesses. Iusacell currently has around 8.6 million subscribers, and its network covers 70% of Mexico's population. AT&T intends on continuing the network buildout to broaden its reach even further.
Including Iusacell debt, AT&T is paying $2.5 billion, buying the carrier from current owner Grupo Salinas (after Grupo Salinas finishes acquiring the remaining half that it does not currently own). Iusacell currently operates a GSM-based 3G network similar to AT&T's and has 800 MHz spectrum licenses mostly in southern Mexico.
AT&T says smartphone penetration in Mexico is approximately half of what it is in the U.S., which implies obvious growth opportunities as Mexico's middle class continues to grow. Iusacell also has visibility into its near-term cash flow, like most utilities, as well as what kinds of capital expenditures it will require.
Always have an out
This all comes as AT&T continues to work to close its acquisition of DIRECTV. Ma Bell expects to close the Iusacell deal in early 2015. After both deals close, the company says its revenue streams will be more diversified across services and geographies.
The Iusacell acquisition makes plenty of sense for AT&T as a relatively cost-effective way to expand into Mexico. AT&T generated $3.5 billion in free cash flow last quarter alone, which more than covers the expected $2.5 billion outlay. Meanwhile, T-Mobile is gobbling up the majority of U.S. postpaid subscribers, underscoring how important it is for AT&T to look elsewhere for growth.
Evan Niu, CFA, has no position in any stocks mentioned. The Motley Fool recommends Vodafone. 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.