T-Mobile/Sprint Merger: A Sure Thing or Doomed to Failure?

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By Jake Saunders | 2Q 2018 | IN-5121

Over the weekend of April 28, 2018, T-Mobile and Sprint announced their plans to merge their operations. Between the two telcos there are considerable synergies. As of the end of 4Q 2017, T-Mobile had 17.1% of the 425 million subscriptions in the U.S. market, while Sprint secured 12.6% of the market. While there would be some subscriber churn during the merger, the merged telco would have approximately a 29.7% market share. Verizon Wireless has a 35.5% market share, while AT&T is just behind with 33.4%. It is not just the aggregate subscriptions that would make the merged T-Mobile/Sprint telco attractive but also the complementary spectrum holdings. Sprint holds almost 60 billion MHz-Pops of spectrum, while T-Mobile holds approximately 35 billion MHz pops of spectrum, but, crucially, Sprint holds a remarkable ~25 billion MHz pops of Educational Broadband Service (EBS) 2.5 GHz spectrum, while T-Mobile holds ~14 billion MHz pops of 600 MHz and 700 MHz spectrum. The merged T-Mobile/Sprint entity would become a serious heavyweight contender in the U.S. market. But will the merger go ahead? Will the Federal Communications Commission (FCC) and the Justice Department give their nod of approval, or will they resort to the courts to block the merger?

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T-Mobile/Sprint Merger… Attractive on Paper

NEWS


Over the weekend of April 28, 2018, T-Mobile and Sprint announced their plans to merge their operations. Between the two telcos there are considerable synergies. As of the end of 4Q 2017, T-Mobile had 17.1% of the 425 million subscriptions in the U.S. market, while Sprint secured 12.6% of the market. While there would be some subscriber churn during the merger, the merged telco would have approximately a 29.7% market share. Verizon Wireless has a 35.5% market share, while AT&T is just behind with 33.4%. It is not just the aggregate subscriptions that would make the merged T-Mobile/Sprint telco attractive but also the complementary spectrum holdings. Sprint holds almost 60 billion MHz-Pops of spectrum, while T-Mobile holds approximately 35 billion MHz pops of spectrum, but, crucially, Sprint holds a remarkable ~25 billion MHz pops of Educational Broadband Service (EBS) 2.5 GHz spectrum, while T-Mobile holds ~14 billion MHz pops of 600 MHz and 700 MHz spectrum. The merged T-Mobile/Sprint entity would become a serious heavyweight contender in the U.S. market. But will the merger go ahead? Will the Federal Communications Commission (FCC) and the Justice Department give their nod of approval, or will they resort to the courts to block the merger?

Peering into the Regulatory Crystal Ball

IMPACT


This is not the first time T-Mobile has walked up the aisle. In March 2011, AT&T tried to merge with T-Mobile, but in August of the same year, the Justice Department moved to block the merger, and by December 2011, AT&T withdrew its bid. Recently the U.S. government has taken a dim view of AT&T’s attempted merger with Time Warner. Is the T-Mobile/Sprint merger therefore also likely to fail? It is ABI Research’s opinion that the arguments are more finely balanced. In the potential AT&T/T-Mobile merger, the Justice Department deemed that the merger would significantly distort the market and confer significant market power to the AT&T/T-Mobile entity. In the case of the potential AT&T and Time Warner merger, while they are in different industry sectors (telcos and cable TV/programming respectively), since telcos and video delivery have enabled Over-the-Top (OTT) delivery the U.S. government has deemed the merger to be a significant risk to “effective competition.”

T-Mobile and Sprint will make substantial efforts to make their case that the merger would be a win-win for the U.S. market as a whole. Refining competition theory has kept economists and company management theorists very busy for decades. The Boston Consulting Group (BCG) has expounded the rule of three and four. A more detailed commentary can be found here,but essentially it declares a “stable, competitive industry will never have more than three significant competitors. Moreover, that industry structure will find equilibrium when the market shares of the three companies reach a ratio of approximately 4:2:1.” At the heart of the BCG thesis is that marketplaces tend to evolve over time to establish this three-competitor (4:2:1) equilibrium. According to this template, the U.S. cellular market certainly is not in this equilibrium and even if the merger were to go ahead, while there would just be three major players in the U.S. market, each would be evenly matched in terms of subscriptions, spectrum resources, and infrastructure assets.

Regulators and government, however, often prefer market competition to be diverse and kept in competitive disequilibrium to ensure there are smaller, more “hungry” companies that would use innovation and competitive pricing to capture subscribers from incumbents. In April 2015, Sharon White, Chief Executive of Ofcom, stated that the company was very much in favor of robust competition: “We sometimes hear the simplistic view that more competition means less potential for investment. I don’t believe that such a trade-off is inevitable, or even necessary. Insufficient competition can lead to insufficient investment; lack of investment can, in turn, undermine choice and quality. At Ofcom we have usually found that it is better to promote competition between providers, and rely on this to spur investment”. This was at a time of BT’s takeover of mobile operator EE, and the acquisition of O2 by rival network Three.

Never Had It So Good

RECOMMENDATIONS


So how will the FCC/U.S. government rule in this merger? The FCC does conduct frequent market competitive assessments. The most recent was completed in September 2017. It stated, “In this Twentieth Report, we analyze competition in the mobile wireless marketplace pursuant to Section 332(c)(1)(C) of the Communications Act, and our assessment of various generally accepted metrics of competition indicates that there is effective competition in the marketplace for mobile wireless services.

ABI Research would agree there has been effective competition in the U.S. market. While end-user “subscriber” adoptions are largely saturated, the adoption of multiple subscriptions for secondary devices (tablets, laptops, dongles, etc.) and cellular Internet of Things (IoT) device subscriptions have been experiencing a growth spurt since 2014. The FCC Wireless Competition report continues to demonstrate that the price per call minute and the price per megabyte consumed have continued to decline. The U.S. mobile consumer has never had it so good.

So, should the FCC keep the current status quo? Not necessarily. While U.S. mobile operators have been very successful, largely on the back of 4G LTE, the U.S. cellular market will face some significant challenges over the next 5 years. 5G could potentially start services in 2019 in the U.S. market, with AT&T and Verizon Wireless keen to commence 5G broadband wireless services. However, 5G will require spectrum in the C-Band (~3.5 GHz) band as well as the 28 GHz band initially. Additional cell sites will be needed to boost coverage.

Over time, existing spectrum bands may be refarmed for 5G and additional millimeter spectrum bands could be made available to mobile operators. While there will be no doubt additional revenue streams to be generated by 5G, much of the first wave of investment in 5G will have to come out of existing cashflow or financing. Mobile operator Chief Financial Officers (CFOs) will be keen to keep overall Capital Expenditure (CAPEX) as a percentage of total revenues within existing financial norms. Given the spectrum requirements of 5G, rolling out Radio Access Network (RAN) coverage and core network upgrades will put considerable strain on mobile operators. Since T-Mobile’s and Sprint’s individual installed subscriptions are approximately half of Verizon Wireless’ subscriber base, or indeed AT&T’s, they both face additional hurdles to build out the same level of coverage as Verizon Wireless. T-Mobile and Sprint have stated that the proposed merger would generate approximately US$1 billion in synergy CAPEX and Operating Expenditure (OPEX) savings, which could be used to invest in 5G coverage and capacity not just in the cities but also rural communities.

It will not be an easy decision for the FCC/Department of Justice to make. The balance of the decision may reflect political imperatives as much as competition theory. If the FCC does allow the merger, it is ABI Research’s opinion that the FCC should stimulate competition by encouraging new entrants to the U.S. wireless market—both complementary industry sector players (e.g., Dish) and smaller entrepreneurial players. It is possible the FCC/Department of Justice will require the merged T-Mobile/Sprint to hand back some of its spectrum, which could be combined with future 5G spectrum to help some new entrants or some of the Tier Three mobile telcos, such as U.S. Cellular, to gain additional market share (currently at 1.2%).