Analysts: Sprint/T-Mobile must merge or one will fail

According to a new, detailed analysis from New Street Research, Sprint (NYSE: S) and T-Mobile US (NYSE:TMUS) need to merge to effectively compete against AT&T Mobility (NYSE: T) and Verizon Wireless (NYSE: VZ), because one of the companies will ultimately fail if they are not able to merge. However, New Street Research said that, if Sprint and T-Mobile attempted a merger today, regulators at the FCC and Department of Justice would move to prevent the transaction.

During the past several months executives from Sprint and Sprint parent SoftBank have been floating the idea of a venture between Sprint and T-Mobile--they have argued that the two must merge to have the firepower to directly compete with the market's two largest wireless carriers. But in public statements officials at both the FCC and DoJ have expressed concern over such a transaction, noting that it could slow competition in the wireless market and ultimately result in higher prices for consumers.

However, analysts from New Street Research argue the exact opposite in a lengthy research note issued to investors. The analysts claim that Sprint and T-Mobile ultimately cannot compete effectively unless they merge, and that evidence from overseas markets indicates that consolidation among wireless carriers that results in three remaining players can lead to lower prices for consumers.

"Our analysis shows that neither Sprint nor TMUS have enough revenue to cover their fixed costs and it is highly unlikely that both will capture enough new revenue to do so," the analysts wrote, pointing out that they believe Sprint and T-Mobile need to raise an additional $10 billion in the next 18 months to remain competitive, an effort that could be stymied by market conditions. "Both companies aren't independently viable at the same time. We show that there simply isn't enough revenue in the industry for four carriers to cover their fixed costs unless there is a significant shift in market share."

Further, the analysts reviewed 21 developed markets to ascertain the effects of consolidation on pricing for end users. The analysts found that in three markets--Netherlands, Greece, and Austria--the number of nationwide competitors dropped from fourth to three and average pricing in the markets declined 15-40 percent after the consolidation occurred.

"Consensus estimates that Sprint will burn $6BN before they start generating cash in 2017, while TMUS will burn $0.3BN in 2014," the analysts noted, adding that both companies need to invest in spectrum in the years ahead to stay abreast of consumer demand. "In both cases, this assumes a strong recovery that will be difficult to orchestrate."

"If the companies merge now, while they are in relatively good shape, the merger will result in lower costs in the context of an improving business, which our data suggests should lead to investment and lower prices," the New Street Analysts concluded. "If the companies are only permitted to merge when one has faltered or failed, the combined company will be less well-positioned to compete against the two well-funded incumbents."

In a separate research note on the same topic, BTIG analyst Walter Piecyk wrote that there are a wide number of factors playing into the situation, any one of which could change the playing field. He noted that Dish Network (NASDAQ: DISH), which continues to purchase significant spectrum holdings, could enter the wireless market and impact the competitive dynamic. Further, cable companies including Comcast (NASDAQ: CMCSA) and Time Warner Cable (NYSE: TWC) are researching ways to use Wi-Fi and unlicensed wireless technologies to cash in on the growth of smartphones and tablets. Indeed, Piecyk noted that Comcast and TWC said as much in their recent FCC filing:  "A ubiquitous Wi-Fi network built by Comcast could make a 'Wi-Fi-first' service, which combines commercial mobile radio service with Wi-Fi, a more viable alternative."

"The wireless industry not only faces new competition from more Wi-Fi buildouts but can also offer new competition to the wired broadband industry," Piecyk concluded. "Competition is not just about lower prices but also about investment in the network, a reality that is likely to be recognized in several European markets that are evaluating the benefits of consolidation."

For more:
- see this BTIG post (reg. req.)

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