John Paulson, the portfolio manager of Paulson & Co. said his firm will vote against the proposed merger of MetroPCS Communications Inc (NYSE:PCS) and T-Mobile USA, the subsidiary of Deutsche Telekom AG (FRA:DTE) (PINK:DTEGY) (ETR:DTE).
The hedge fund owns 36.3 million shares or a 9.9 percent stake of MetroPCS Communications Inc (NYSE:PCS) and it is the largest shareholder of the company.
In a letter to the company's board members, Paulson said the structure of transaction is not in the best interest of shareholders citing that the pro forma company has too much debt with a very high interest rate, which will make it difficult to compete in the U.S. wireless industry.
He argued that the deal creates “disproportionate risk” for the shareholders of MetroPCS Inc (NYSE:PCS). The hedge fund manager believes that the company is more valuable as a stand-alone company and it has the freedom to execute its own successful strategy independently while exploring better and higher offers.
The structure of deal is reverse merger wherein T-Mobile combines with MetroPCS, which is already a public company. Deutsche Telekom AG (FRA:DTE) (PINK:DTEGY) (ETR:DTE) will own 74 percent of the combined company and the remaining stake will be held by MetroPCS shareholders plus they will receive $1.5 billion in cash. Paulson pointed out that equity split is unfair because MetroPCS will contribute 42 percent but its shareholders will only receive 26 percent.
Paulson supports the position of P. Schoenfeld Asset Management that the combined MetroPCS and T-Mobile business will be burdened with a huge amount of debt of around $23.2 billion including a $15 billion intercompany note held by Deutsche Telekom AG (FRA:DTE) (PINK:DTEGY) (ETR:DTE). The combined company will also pay a very high interest rate of 7 percent on the $15 billion intercompany debt, which is 67 percent higher than the existing yield of Sprint Nextel Corporation’s (NYSE:S) 2020 bonds.
The hedge fund manager explained, “The net debt to 2013 EBITDA multiple is 3.6X, 125 percent higher than Verizon, the next most levered peer.”
Paulson emphasized that the debt puts the combined company in a significantly disadvantage position in competing against peers in the industry. It also creates enormous risk for the pro forma equity that will be owned by MetroPCS shareholders.
According to Paulson, MetroPCS Communications Inc (NYSE:PCS) financial performance is good as an independent company with a record 2012 EBITDA of more than $1.5 billion, 14 percent higher than its 2011 EBITDA. The company’s EBITDA margins increased by 216 basis point to 29.6 percent, and the number of its 4G LTE subscribers increased by 17 percent to 2.2 million. He said, MetroPCS is performing better than T-Mobile and it “cannot support a deal wherein the company gets much lower value than what it is contributing.”
Paulson said he will only support an agreement wherein the terms reflect a lower intercompany debt and interest rate such as the recommendation of Jonathan Chaplin of New Street Research. Chaplin suggested that Deutsche Telekom should reduce its debt contribution by $6.6 billion. In terms of the interest rate of Deutsche Telekom’s notes, Paulson recommends 4.2 percent, a rate similar with Sprint’s existing yield.
The shareholders of MetroPCS Communications Inc (NYSE:PCS) are scheduled to vote on the deal on March 28. Both companies expect the merger to close in April.