AT&T + T-Mobile: The merger that was hiding in plain sight

Roger Entner is Analyst and Founder of Recon Analytics. www.reconanalytics.comToday, AT&T announced it will acquire T-Mobile USA for $39 billion. This combination highlights that analysts, pundits and regulators alike are often surprised by how quickly and unexpectedly events overtake speculation. As a result of the 64 percent cash, 36 percent equity transaction, Deutsche Telekom will own about 8 percent of AT&T. There are so many winners in this combination: At a 7.1x EBITA multiple and about $1,000 per sub, AT&T has struck a great bargain.

Deutsche Telekom, which acquired VoiceStream for $24 billion in 2001, is profitably exiting a growing headache. It also brings to a conclusion Philipp Humm's five-month mission to either turn around the operation or to sell it. T-Mobile USA customers who have suffered through years of underinvestment in T-Mobile's network are joining an operator with a track record of bringing innovation to Americans.

Unlike the rumored combination of T-Mobile and Sprint, which never made much sense on so many levels, the AT&T/T-Mobile combination provides a clear technology roadmap with a straightforward integration path that will let T-Mobile and AT&T customers escape an impending capacity crunch. With a minimum eight- to ten-fold increase in data usage until 2015, wireless operators do not have the luxury to wait for the promised 500 MHz of spectrum to be cleared and auctioned by the FCC, but have to act now.

The merger will increase cell site density in urban markets by 20 percent to 40 percent improving customer experience immediately. In addition, AT&T commits to bringing LTE to 95 percent of all Americans. This is more than the 90 percent that Verizon has announced to cover with LTE and very close to this administration's goal to bring broadband to 98 percent of the population. With an additional $8 billion over seven years investment of AT&T in its network due to this merger, the positives for AT&T and T-Mobile customers are significant.

The proposed acquisition will be closely scrutinized in Washington, D.C. Both the FCC and the Department of Justic have a generally less hospitable attitude towards industry consolidation than the previous administrations, an attitude perhaps heightened by staff that has spent time at "big is bad" advocacy organizations, where they have generally argued against such mergers. It will remain to be seen if their arguments against similar mergers when they were on the outside will carry more weight now that they among the decision makers on the inside.

One of the critical measures both the DOJ and the FCC look at is the Herfindahl-Hirshman Index. The FCC in its 14th CMRS Report determined that the Herfindahl-Hirshman Index (HHI) weighted by population was 2848 in 2008, a value that is one of the lowest in the world. In the past, such mergers were evaluated on a market-by-market basis. The below table from the FCC's 14th CMRS Report shows us the HHI's of individual markets by population density.

Source: 14th CMRS Report, FCC 10-81

As the table shows us in metropolitan markets the HHI is significantly below 2800. Only, the most rural markets with a population density of less than 100 is pushing the HHI above 2800. Since T-Mobile is generally not active in these rural markets the HHI will therefore not move or can easily remedied through a divestiture.

The other big wildcard in the HHI analysis is TracFone. The FCC has traditionally excluded TracFone, the fifth largest service provider in the United States from its HHI analysis because it argued that MVNOs, in general, were unable to effectively compete against facilities-based operators and because it lacked market share data on a market-by-market level. TracFone's success over the last few years clearly shows they are more than able to compete against facilities-based operators. In 2010 alone, they grew faster than Sprint, T-Mobile, U.S. Cellular, and MetroPCS combined. If market share data by market for TracFone becomes available to the FCC and it recalculates the HHI on that basis, the HHI inevitably will drop.

The expected market entrance of LightSquared, which was significantly aided by the FCC's decision to waive the ATC requirement could also reduce anti-trust concerns as a new entrant is coming to the market. At the same time, the FCC argued in its justification for their approval of the waiver "that LightSquared's network will enhance competition for terrestrial mobile wireless broadband services, giving consumers additional options when choosing a broadband service provider."

This merger is both an opportunity and risk for Sprint. It will allow Sprint to more clearly define itself as the value leader in the U.S. market and create more space for it in that segment. The announcement of this deal could serve as a wakeup call that it needs to reap more quickly the benefits from its Clearwire relationship and from its Network Vision initiative.

In summary, the FCC and DOJ have to decide to break with the past of looking at the mere number of providers and instead looking at the track record of companies bringing innovation to Americans. It also has to recognize that T-Mobile's parent is clearly interested to reduce its exposure to the U.S. market and take that into account when making a decision.

Roger is Analyst and Founder of Recon Analytics.