December 21, 2011
It does not come as a real surprise that the deal aimed at merging AT&T's and Deutsche Telekom's US wireless operations got nowhere. We were expecting as much back in autumn. In our view, there are no winners as a result of this dropped deal, not even the US consumer. The US consumer can look forward to poorer network infrastructure and a weakened T-Mobile as the low-end market provider. Hence, the Federal Communications Commission and Justice Department attained somewhat of a Pyrrhic victory.
Whilst the collapsed deal is a major irritant for AT&T, it is a disaster for Deutsche Telekom, as it leaves T-Mobile US in a very difficult position. With about 10% of the US wireless subscribers, T-Mobile US remains subscale. Its image is increasingly trending toward cheap rather than good value, given its patchy network coverage, especially in rural areas.
The reluctance by Deutsche Telekom to prepare for a "no-deal scenario" leaves T-Mobile without a clear strategy. This lack of direction is very risky and only pushes T-Mobile further down a slippery slope toward increasing churn and revenue and margin challenges. Deutsche Telekom needs to communicate its plans for 4G roll-out, spectrum purchases, partnerships for network sharing, and device portfolio. Above all, Deutsche Telekom needs to decide soon whether to pursue an IPO, a sale to another operator or a financial investor, or target a merger with the likes of Dish, Leap, Clearwire, Sprint, or even LightSquared. Ultimately, we expect Deutsche Telekom to opt for a merger scenario.
Given the market conditions at present, any such merger with another operator would most likely result in 1) a lower price than the $39 billion that the AT&T deal promised and 2) a high-equity stake rather than cash payment, which would translate into long-term investment commitments. In any case, no deal is likely to be as attractive as the AT&T deal, which valued T-Mobile at around 7 x 2010 EBITDA.
In the absence of any near-term deal for T-Mobile US, Deutsche Telekom will be forced to tackle investment requirements for large network upgrades. To make matters worse, Deutsche Telekom just missed out on a recent round of spectrum sales as it expected the deal with AT&T to close. The €3B cash break-up fee, a UMTS roaming agreement, and some wireless spectrum that AT&T will hand to Deutsche Telekom due to the "no-deal scenario" will go some way to soften the blow. But the blow still remains a major blow.
The real costs to Deutsche Telekom will be felt not in North America, but in Europe, in particular Germany. The deal collapse impacts Deutsche Telekom Group's cash flow via higher interest payments and missing dividend payments from AT&T. This in turn will have implications for Deutsche Telekom's network upgrade and strategy innovation plans in Europe. The implications of these missing investments will be felt over the long term.