Is it time for MetroPCS and Leap to finally merge?

The bonanza we saw in the prepaid segment during the first quarter has now fizzled in the third quarter as MetroPCS and Leap Wireless reported lower-than-expected subscriber additions and T-Mobile saw a major slowdown in prepaid subscribers. The economy and competition are taking their toll on those companies that were just a few quarters ago the darlings of the industry in a struggling economy.

MetroPCS saw a dramatic slowdown in subscriber additions--66,000 compared with 249,000 the previous year and 206,000 in the second quarter. Leap Wireless saw its net customer additions fall 25 percent, adding 116,000 in the quarter, compared with 156,000 the previous year and 203,000 in the second quarter.

While seasonality is partly to blame, consumers now have a plethora of prepaid offerings to choose from.

"We were disappointed with this quarter subscriber growth," said CEO Roger Linquist, during the company's third-quarter conference call, according to transcripts from Seeking Alpha. "Our gross additions and particularly our net additions were below our expectations... Going forward, additional adjustments will be required... While we believe we're best dealer in town, the competitive landscape has changed since the beginning of the year. The consumer now has more competitively priced unlimited no contract service options."

Linquist also stressed the necessity of being able to provide nationwide service. He described it as a "basic requirement," meaning the operator will have to continue adding roaming partners.

Indeed, Sprint and its prepaid offering from Boost Unlimited appears to be the only prepaid wireless provider that reported any traction. At the beginning of the year, Boost Mobile launched a $50 per month unlimited voice and data plan on the iDEN network that includes voice, text messaging, mobile web access and PTT on a nationwide basis. Both MetroPCS and Leap offer similar plans but they don't have nationwide offerings.

Wal-Mart's Straight Talk, introduced in October, could do some major damage too now that it is nationwide. The no-contract services, available exclusively via Wal-Mart stores and online, include a $30 "All You Need" option featuring 1,000 minutes, 1,000 texts and 30MB of mobile web access per month--unlimited monthly minutes, text and web access cost $45.  

We can also fully expect T-Mobile to come out with a better offering after its poor third quarter results that saw a loss of 77,000 subscribers. It's prepaid offering recently introduced was largely disappointing to analysts because it was a premium to other nationwide offerings out there. AT&T's GoPhone offering at $60 is higher but it has better distribution and footprint than MetroPCS and Leap. In short, nationwide postpaid providers will continue to encroach on the turf of MetroPCS and Leap.

So I guess you can see where I'm going. The pressure is on for MetroPCS and Leap to merge. But MetroPCS insists it's not on the horizon. Adding roaming partners appears to be the company's route.

"We personally have no, shall we say, interest in pursuing the transaction you are talking about," Linquist said in response to a question from an analyst about whether it might consider a union with Leap. "And the primary reason right now is that if on some circumstances in the future, there could be an opportunity, obviously we would be open to that, but we have the footprint. The key from our standpoint is we have the coverage, we feel we are beyond the critical mass of a nationwide footprint that is important to our customers, so that to us is the key element."

Clearly investors have been worried about the saturated market as both stocks have taken beatings since the second quarter. Obviously the combination of MetroPCS and Leap would create an entity with significant financial and coverage leverage against postpaid players becoming more aggressive in the space.

But there's never been any love lost between the two companies. Leap Wireless rejected a takeover bid from MetroPCS in 2007, while Leap has claimed in the past that MetroPCS has rebuffed any merger discussions. The two companies have a bitter history that dates back more than 10 years.

MetroPCS executives have always told me through the years that Leap stole the original idea of unlimited local pricing service from MetroPCS. MetroPCS just couldn't come to market first because it filed for bankruptcy after spending too much at the C-Block PCS auction in the mid-1990s. In 2006, Leap filed suit against MetroPCS in a Texas court claiming MetroPCS violated patents over the unlimited pricing plans. However, the two have managed over the years to create reciprocal roaming agreements.

Many commentators, including me, have been arguing for a combo since 2007, but now it appears the market may be finally reaching the point that makes a merger a necessity. The next few quarters, especially the critical fourth quarter, will likely bring that reality home to both companies--at which time they'll have to deal with that major culture issue of control.--Lynnette