AT&T's Sweet Deal Is Easy Money
03/30/2011 3:18 pm EST
Last week’s purchase of rival T-Mobile looks like a big winner for the telecom giant, which is poised to do well even if the merger gets nixed, writes Roger Conrad, editor of Utility Forecaster.
AT&T’s (T) move last week to acquire No. 4 US wireless firm T-Mobile USA from Deutsche Telekom (OTC: DTEGY) looks like a major winner for the company. AT&T is taking advantage of the German giant’s decision to monetize its investment, rather than spend billions more to keep it competitive.
AT&T’s offer is valued at roughly $39 billion—$25 billion in cash, plus $14 billion in stock that will give Deutsche Telekom about 8% ownership of AT&T. There’s also a $3 billion breakup fee if Ma Bell walks away.
If the merger is approved, AT&T will pick up another 46.5 million customers, bringing it close to 130 million total—well ahead of No. 2 Verizon Communications (VZ), which owns Verizon Wireless in a partnership with Vodafone (VOD). That adds up to about a 40% share of the US wireless market.
These customers all use GSM technology, which eliminates the technical challenges that plagued the rumored takeover offer from Sprint (S).
In recent years T-Mobile has been unable to keep up with AT&T and Verizon, particularly with offerings of increasingly popular smartphones and related data services. AT&T will have numerous opportunities to improve performance and product reach for consumers, boosting revenue and cutting costs in the process.
The deal will require approval from the Federal Communications Commission (FCC) as well as the US Department of Justice. These reviews are expected to exhaustive and, judging from the reaction so far, highly contentious, as rivals, consumer advocates, and congressional Democrats weigh in with demands for conditions—and even outright opposition.
Counting Noses, Trading Horses
The FCC last year declared the wireless industry “not competitive” for the first time ever. Democrats hold a 3-to-2 majority on the FCC, by virtue of the president’s power to appoint more members of his own party.
On the other hand, the deal has the potential to eliminate a pending “spectrum crunch” that is the FCC’s biggest current challenge. It should also speed up the introduction of advanced services and smart phones into rural areas.
AT&T’s calculus seems to be that regulators will wind up approving the deal to further these objectives—and that any conditions and divestitures imposed will not appreciably reduce the benefits from the deal.
The company does face a $3 billion breakup fee if it walks away. But it also stands to gain from the de facto elimination of a competitor while regulatory approvals are ongoing. That will further extend its operating advantage over T-Mobile—even if the deal fails, it will still be in a superior position.
As for the financial cost, AT&T management projects $7 billion in “integration” expenses and $2 billion in additional capital costs resulting from this deal. That’s in addition to the $25 billion in cash needed for the acquisition.
Benefits from the deal, meanwhile, are expected to show up in 2012—assuming the deal is approved in six to nine months, as expected.
That’s a price tag that would stagger most companies.
AT&T, however, has already snared a $20 billion, one-year bridge loan to do the deal. It’s assuming no debt from either Deutsche Telekom or T-Mobile itself.
And the company earned $3.1 billion in free cash flow (cash flow less capital expenditures) in the fourth quarter of 2010 alone, and $14.7 billion for the full year. That was on top of $17.1 billion the year before, with a similar amount projected for 2011. AT&T also had $15 billion-plus in current assets as of year-end 2010.
In short, this is one of the very few companies in the world that can definitely afford a deal of this size. Yielding more than 6%—and set for solid 5% to 7% earnings growth the next five years—AT&T is a buy up to $30, and a superb total return play with or without this deal. [Shares nudged that buying threshold Tuesday and kept right on going, fetching nearly $31 in recent market action—Editor.]