Will The T-Mobile – Sprint Merger Finally Come to Fruition?

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The rumored T-Mobile and Sprint merger may be back on track, with Reuters reporting that the two companies are now close to reaching “tentative terms” on a deal that could be announced by the end of October. Reuters reports that Sprint shareholders and its parent company Softbank will own between 40% to 50% of the combined entity, with T-Mobile’s shareholders, including Deutsche Telekom, owning the majority stake. T-Mobile’s CEO John Legere is likely to lead the merged company if a deal goes through. In this note, we take a look at some of the potential obstacles that the deal could face and how it could add value for shareholders.

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The Deal Would Be Significantly Value Accretive

The cost synergies stemming from a merger could be sizable. Wireless is a very high fixed cost business, on account of sizable network operation and maintenance costs as well as sales and marketing expenses. For instance, T-Mobile’s cost of services (excluding depreciation) and SG&A costs together stood at about $17 billion last year, while the same two cost buckets for Sprint totaled $16.3 billion. If we assume that the combined entity is able to cut total costs by just about $1 billion for the first year post-close – with net cost savings coming in at $2 billion in year two and remaining at ~$3 billion from year three to perpetuity – the present value of synergies after tax (35% tax rate and 9% discount rate) would stand at roughly $20 billion, per our estimates.

The two companies could also avoid a lot of unnecessary capital expenditures in the future, as the wireless industry is on the cusp of a transition from 4G technology to the next generation 5G technology. Sprint has a deep portfolio of 2.5 GHz spectrum holdings that could be used for 5G deployment, allowing the combined company to avoid some outlays that they may otherwise have to undertake individually.

There could be some revenue synergies as well. The joint entity would have a total of 130 million wireless subscribers, a little behind market leaders Verizon and AT&T, who had 147 and 136 million subscribers, respectively, as of the end of June. Postpaid phone subscribers could stand at 59 million, versus about  64.6 million for AT&T. This consolidation could help to improve pricing power in the wireless industry, as the rivalry between Sprint and T-Mobile was partly responsible for dragging down prices in the broader U.S. wireless market. Separately, the wider distribution footprint could also help the combined entity grow its subscriber base.

Terms Need To Be Figured Out, Regulatory Concerns Could Still Persist

There is a sense that the regulatory environment for big-ticket telecom mergers may have improved under the Trump Administration – which is seen as being more business-friendly. The FCC and the Antitrust Division of the Justice Department, which was in large part responsible for scuttling the proposed 2014 merger between the two carriers, could examine the combination differently. For instance, FCC Chairman Ajit Pai appears to have moved away from his predecessor Tom Wheeler’s view that the U.S. should have four national wireless carriers.

That said, a merger could still face intense regulatory scrutiny. The competition between T-Mobile, Sprint and the larger two carriers has been good for U.S. wireless consumers, fostering a lot of innovation while helping to keep pricing in check. Per the BLS, the consumer price index (CPI) for wireless services was down by almost 13% year-over-year in July 2017.  This could give the deal an appearance of being anti-consumer, resulting in some regulatory hurdles.

The two companies will also have to reach mutually agreeable terms, and Reuters has reported that there is a possibility that the talks could still fall through. While T-Mobile might have the upper hand in negotiations, given its larger market capitalization and the fact that it has been posting the strongest subscriber growth in the industry, Sprint could also play hard to get. In June, the carrier was in exclusive talks with cable behemoths Comcast and Charter Communications, who have been increasingly interested in entering the wireless market. It is possible that Sprint could have used the negotiations as a bargaining chip to extract a more favorable deal with T-Mobile.

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