This Sunday, AT&T and T-Mobile USA operator Deutsche Telekom AG made a huge merger announcement. AT&T, the United States’ second largest wireless operator, agreed to acquire the fourth largest provider, T-Mobile, for $39 billion in cash and stock.
The merger has been rumored in the industry for a few years now, as AT&T and its neck-and-neck rival Verizon Wireless have jostled to take the crown of largest provider in the nation. But, few really thought it would happen. Sure, T-Mobile has failed to execute well in the U.S. for years. Yes, wireless continues to consolidate. Could it ever make it past the regulators, however? Well, a lot can change in a few years.
AT&T itself is an example of exactly the kind of unexpected change that does occur occasionally. When the former iteration of the company tried to merge with SBC in 1987, the deal was labeled “unthinkable” by then FCC chairman Reed Hundt. Now, consumer advocate group Public Knowledge is calling for the same label to be applied to this deal. Ironically, just seven years after the SBC merger failed, the reverse happened – SBC took over AT&T Wireless, adopting the acquired company’s moniker and forming the company we know as AT&T today.
Only time will tell what action the regulators will take. But if the deal is approved, there will be many parties affected, from competitors to partners to consumers, not just by the deal itself but from what will probably follow – more regulation and further consolidation.
The Merger Terms
Not all of the details of the proposed deal have been announced just yet, but the companies have been pretty forthcoming. What we know so far: $14 billion of the purchase price will be paid in stock, which means at the end of the deal Deutsche Telekom (DT) will own about 8% of AT&T, and will have walked off with about $25 billion in cash. Some of these terms are subject to tweaking as the deal comes to a close, but net DT will own at least 5% of AT&T, and the purchase price will remain flat even if the split adjusts.
If the deal fails to garner regulatory approval, AT&T will still owe $3 billion to T-Mobile as a “breakup fee” and will have to transfer over some of its spectrum not being used in the company’s LTE rollout. Plus, they will come out with a better than previous roaming deal across the two networks. So, a dejected T-Mobile may at least come out more competitive than it was before on the cost and spectrum side, though brand questions will probably linger for years.
The combined company would hold about 130 million wireless subscriber accounts, making it the largest wireless provider (passing Verizon Wireless’ 102 million subscriber accounts). But the big deal from AT&T’s perspective is the increase in potential “POPs” – industry jargon for “point-of-presence,” or the people covered by a line of service – for its next generation “4G” LTE technology-based network. Prior to the merger, the company would have been able to cover about 247 million POPs with its rollout plans. If the deal goes through, the number jumps to 294 million, or about 95% of the American population.
AT&T is not just buying subscribers here. They are buying wireless spectrum to allow them to stay competitive with Verizon Wireless, which is planning to make LTE available to 200 million POPs available just by the end of this year, and can theoretically launch to their entire network covering 97% of Americans.
The companies themselves are likely to be massively impacted by a merger of this size. But there have been no announcements of plans for consolidation and cost reductions (such as layoffs) thus far. With so much regulatory scrutiny likely to be applied to the deal, it is probably wise of the companies to keep mum on that subject as long as they can.
Merging Networks
Another thing yet to be discussed much publicly, but certainly on the table behind the scenes, is the actual technical process for merging the two networks. Ericsson is the majority equipment supplier for both companies, and you can be pretty sure they were brought to the table early on to ensure the process would be smooth.
Many comparisons are sure to be made soon between this merger and the one between Sprint and Nextel, which is largely viewed as a complete failure. The integration of those two companies might have been smoother if Sprint hadn’t made the decision to operate the two networks independently.
Instead of sinking the capital cost upfront into shutting down Nextel’s iDEN network and recapturing the frequency for use in its own network, Sprint instead kept iDEN running side by side with its PCS technology based network – operating two networks at three times the cost essentially, since iDEN was costly to run with no other major networks in the world left supporting it.
The result was massive customer churn as both networks lagged competitors on reliability and coverage. The mistakes wiped out any value from the merger, and cost Sprint billions in lost revenue from the massive outflows of unhappy customers who saw networks improving elsewhere. Only now – just over six years since the merger was announced – has Sprint begun the process of moving Nextel “push to talk” customers over to the Sprint network.
AT&T’s and T-Mobile’s networks are far more compatible than that previous wireless mega-merger, both running on the global standard GSM technology. And they have surely learned from the mistakes of their competition, and included a build-out plan in the deal – one that T-Mobile (TMo) and Ericsson are probably hard at work implementing right now. Even if the deal does eventually fall through, don’t be surprised to learn that TMo has changed its development path and headed whole hog into LTE, an announcement (and multi-billion dollar investment) they had yet to make as they’ve waffled with their future. Whether they want to successfully join AT&T or be able to compete on their own if the merger fails, LTE is probably the right – or only – move for TMo.
If the merger does go through, AT&T will be able to use the TMo network to its advantage. AT&T’s biggest problem right now is its network’s perceived reliability. Stories of dropped calls, inability to get a basic signal in dense metro areas like New York and San Francisco, and troublesomely bad data throughput are all very common complaints about AT&T. Verizon’s relative reliability is its strongest marketing point.
AT&T will surely spin this deal as an investment in improving that experience. Their telling quote so far has been that there will be “straightforward synergies” thanks to “complementary network technologies, spectrum positions and operations.”
And it might well be… eventually. But it will take years for the combined company to merge the networks and get handsets to a majority of consumers that can take advantage of the expanded spectrum. – even if they are starting out on a much better footing than Sprint did.
Unique Features
There’s one small wrench in the works for AT&T – just as the unique push-to-talk service caused problems for Sprint in absorbing Nextel, TMo comes with its own unique little feature that AT&T may struggle with keeping around, called UMA. This simple feature switches a phone call between the cell phone network and WiFi at one’s home, office, or public hotspot, when available. This can mean much-improved coverage for people using their phones at home or in an office with bad reception, and also offloads some work from TMo’s network.
UMA is not very broadly adopted, but the consumers who have it seem to love it. It’s been a major loyalty point for TMo for the past two years. The question remains whether AT&T will keep TMo’s network running to stop those customers from defecting, just kill the feature and deal with it, or move the feature to its own network and start to use it as a competitive advantage in marketing over Verizon. Luckily for AT&T, no other provider has a viable competitive solution out yet. But they have at least a year to get one up and running. And you can expect many are already trialling the idea as a cost savings measure to begin with, so it might not take them too long to roll it out.
The Other Players
For Ericsson, which as we’ve already discussed is the major infrastructure vendor for both parties, the impact of the deal will likely be felt in two distinct ways.
On one hand, they will have one fewer player to negotiate with, driving down their leverage on pricing and service terms. The same becomes true with everyone in the industry from backhaul networking suppliers to keystone patent licensors. But most of these companies – other than labor-intensive operations like tower management firms – are more global than local, and the total number of players doesn’t change. For many it may mean dropping margins in the U.S., but will also mean larger ones in Germany with a smaller Deutsche Telekom.
On the other hand, AT&T and TMo both will be accelerating their network upgrades and other changes in preparation for this deal. AT&T already has pegged its own spending increase at $8 billion as a result (over an undefined time frame). One result of the frantic rush to consolidate technical operations, added to the already speeding up LTE deployment battle, may be a mini boom time for wireless network suppliers that can offer solutions to the GSM/LTE merger’s complexities. They include firms with software-based controls in their equipment for instance, whose radios will work well across the variety of frequencies the combined company would be dealing with.
Handset makers will face similar reduction in suppliers. For low-end providers like Nokia, it potentially spells bad things as price pressures mount. For Apple – which enjoys strong premiums on their iPhone devices thanks to high consumer demand and profitable data contracts for the carriers – there might be more incremental opportunity with 30 million additional customers than margin pressure. Of course, it pales compared to the recent Verizon deal which brought them within reach of over 100 million more subscribers.
One company sure to get the short end of the stick in this deal? Publicis Groupe, the ad agency responsible for TMo’s MyTouch 4G ad campaign with its pretty girl in a purple dress taking pot shots at AT&T’s network through a series of commercials based on the now-infamous Mac vs. PC campaign from Apple a few years back. We doubt AT&T will be renewing that contract.
Regulatory Scrutiny and More Consolidation
Really, the big winners in this deal are likely to be the regulators. This deal represents an opportunity for politically motivated bosses in the FCC, FTC, Justice Department, and elsewhere to sink their teeth in to the merger and extract a pint of blood. That payoff is likely to come in the form of backing from the combined company for policy changes – like the controversial “net neutrality” provisions that FCC chairman Julius Genachowski has made his personal crusade of late.
Other potential givebacks could include releasing some of the billions of dollars in spectrum the combined company would control, to allow for more competitors to pick up a share of the limited resource; or the perennial lawmaker favorite, rural access and broadband.
In evaluating these types of mergers, Justice Department officials often turn to a measure called the Herfindahl-Hirschman Index (HHI). This simple measure squares the market share of each firm in an industry and sums those figures, developing a number from near zero up to 10,000 in an industry with a 100% monopoly. The FCC has been actively tracking this number for some time, firing somewhat of a warning shot toward the industry last year when it released the following chart tracking the upward momentum of the HHI index for the wireless industry:
A quick back-of-the-envelope calculation indicates that the merger, if it were to happen today, would bump the HHI up another 600 to 700 points. That would be a considerable increase over recent levels, and likely to draw scrutiny from regulators. AT&T of course is not blind to this, and has already warned it could take up to a year to garner approval for the deal.
They have also gone on the offensive from the start on the subject of competition with a whole section of the merger announcement dedicated to the subject. Among other things, they cite the government’s own data when they say, “the overall average price (adjusted for inflation) for wireless services declined 50 percent from 1999 to 2009, during a period which saw five major wireless mergers.”
This merger alone is not likely to be the concern cited by regulators, of course. It becomes about setting a precedent, and raises the question of what additional consolidation the deal might bring in its wake:
- Will Verizon strike back at AT&T after it takes the number one spot, by trying to purchase third-place provider Sprint, whose PCS network is nearly as compatible with Verizon’s as TMo’s GSM network is with AT&T’s?
- Will equipment providers consolidate further to try to buy back some additional leverage in negotiations?
- Is someone is likely to scoop up the few remaining independent outfits like Chicago-based U.S. Cellular, or San Diego outfit Leap Wireless? The latter’s stock is up some 13% intraday on speculation in the wake of the announcement, after being battered recently on terrible management performance.
Further regulation is sure to stifle the advancement of technology, incentivizing the status quo over continued change. And change has been the lifeblood of the Internet and mobile economies, as they’ve displaced everything from landlines to storefronts to personal computers for huge swaths of the world population. At this point we can only hope that the attachments to this deal’s eventual approval aren’t too severe. Of course, given that much of the regulation would help cement the biggest players’ competitive positions, AT&T is likely to agree to support all kinds of initiatives in the name of getting this deal done.
Ultimately, this deal will concentrate more pricing power in the hands of fewer players in the U.S. wireless space if it goes through. That means stronger negotiating power for them over equipment purchases and more economies of scale to drive down both device and access costs. But it also means fewer competitors to hammer on each other’s margins, and likely higher consumer prices on a relative basis – though technology and competition have forced prices down faster than margins have risen for some time now, and that shows little sign of slowing.
Thankfully there are still major countervailing winds with Sprint and Verizon, along with some new wholesale networks in the build out phase that could one day spawn another viable competitor. These same arguments will be made by AT&T as well, and are the ones on which the approval or denial of the deal will rest. That said, once the regulators get their pet reforms through and their sound-bite time in front of the camera, we expect relatively clear sailing for the deal.
