What to Do with AT&T

09/06/2011 8:30 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

It was no surprise that one of the biggest telecom mergers of all time was going to hit some snags. Now it's time to explore the implications, writes Roger Conrad of Utility Forecaster in this special exclusive to MoneyShow.com.

The US Department of Justice has filed to block AT&T’s (T) $39 billion purchase of Deutsche Telekom’s (DTEGY) T-Mobile USA.

That doesn’t automatically kill the deal. AT&T has vowed to fight in court, and companies have in the past won such battles. Moreover, the Federal Communications Commission stated today the DOJ move will not impact its own decision-making process, though it now seems likely to offer objections as well.

At a minimum, however, the DOJ challenge will make it much harder to complete this transaction in a timely manner. And the standard the Obama Administration is setting also seems to make a compromise less than likely—mainly that AT&T and DT must not just provide assurance that customer rates won’t rise, but that they wouldn’t fall faster if this deal is scotched.

That seems an impossible standard for any deal to meet. Ironically, contrary to all the bluster we’re hearing now, killing AT&T/T-Mobile will have little if any impact on the ongoing consolidation of the US wireless business, or even AT&T’s growing market dominance.

The reason is money. Mainly, AT&T and arch-rival Verizon Communications (VZ) are spending $5 billion each quarter on building their networks.

No. 3 US wireless company Sprint (S) was able to scrape together $1.4 billion, a solid increase from last year’s $922 million. But with a BB- credit rating and $2.3 billion in debt coming due in mid-March, it’s hard to see how they’re going to do much more without taking on a crippling amount of additional leverage.

T-Mobile’s parent DT, meanwhile, spent less than $2.8 billion worldwide. That’s down from $4.8 billion last year, as the company struggles with competition in Europe, and deals with more than $5 billion in maturing debt over the next 12 months.

The money gap means that AT&T and Verizon enjoy an ever-widening advantage over the rest of the industry in terms of technology they can employ to improve network speed and quality. That ensures they’ll continue to grab an ever-larger piece of the most profitable segments of the US wireless market, just as they have every quarter for the past few years.

Meanwhile, rivals will be forced to compete more and more on price for less attractive customers.

DT would get a $3 billion cash infusion, plus network access worth an estimated $4 billion, should regulators reject the deal and/or AT&T walks away. But that’s hardly compensation for the $39 billion it would have received in a profitable exit from US operations, which management clearly deems are not core to its long-term strategy.

That makes DT clearly the big loser from today’s DOJ move. And this move is also likely to chill any foreign capital interest in taking a stake in US wireless—the implicit message is that Uncle Sam may not let you sell in a timely manner.

But despite today’s volatility, investors have little to fear from owning AT&T. Rather, the company will continue to win the most profitable customers of both Sprint and T-Mobile, even as they expand data revenue.

Those who don’t own AT&T should take advantage of any further dip in price to buy below my long-standing buy target of $33. Verizon is a buy up to $40. [AT&T closed just above $28 going into the long weekend; Verizon closed at $35.56—Editor.]

As for DT, my advice for several months has been to sell. That’s still my call despite today’s dip.

And by all means, take advantage of today’s uptick and sell any Sprint shares, despite media hype that they stand to benefit from the failure of AT&T/T-Mobile. Sprint’s president of network operations, Steve Elfman, may have tipped his hand in an interview today following the DOJ move, stating T-Mobile “will need to hook up” with another company if the AT&T deal fails.

A T-Mobile/Sprint union would certainly be in character for management that has shown in the past to act before thinking. But it would involve taking on a huge amount of debt, as well as integrating yet another disparate network along with Nextel’s and the company’s troubled investment in Clearwire.

That kind of empire building rarely works out well for anyone, except rival companies.

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