The Wall Street Journal said Friday that Sprint Corporation (NYSE:S) was mulling a takeover of rival T-Mobile US Inc (NYSE:TMUS) and could launch a bid as early as the first half of next year.
Regulatory concerns place a shadow on the feasibility of the transaction, given that two years ago a $39B proposal by AT&T Inc. (NYSE:T) was rejected by the Department of Justice on anti-trust considerations.
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Citi’s view on Sprint and T-Mobile US
“We believe the industrial and financial logic of a large scale industry consolidation scenario makes compelling sense for Sprint. We view the key opportunity for Sprint is to leverage a merger with T-Mobile US Inc (NYSE:TMUS) to improve marketing scale relative to Sprint Corporation (NYSE:S) and AT&T Inc. (NYSE:T), which we view contributes to the most significant variance between Sprint’s OIBDA margin and its two largest competitors once the company captures the full savings from Network Vision,” say Citi analysts for Telecom led by Michael Rollins in their research note issued today.
According to the analysts, the merged company would be able to engineer annual operating synergies of approximately $2B, and this could favorably impact the valuation of the merged entity. This apart, the transaction would satisfy ambitions nurtured by Softbank Corp (TYO:9984) (OTCMKTS:SFTBF) and Sprint to catalyze further consolidation in the wireless industry by achieving greater scale in network spread and marketing activities.
By Citi’s estimates, the HHI, a measure of market concentration used by the DoJ and the FCC, could range between 2,504 and 3,592 depending on whether it is computed with respect to subscribers, revenue or spectrum, as shown in the figure below:
Save one reading, all of these readings of the HHI are above the 2,800 threshold, a point beyond which the DoJ and FCC conduct a rigorous competition review of the proposed transaction.
“Our conclusion is that the elevated level of industry concentration is likely to push the review to a more qualitative assessment as to whether or not a larger #3 carrier can more effectively compete against the #1 and #2 carriers,” say the Citi team, stressing that obtaining regulatory approvals could be a difficult process.
The merged company
Based on estimates for FY14, Citi view the metrics of the merged entity as follows:
The deal would likely be structured as an all-stock transaction, given the high leverage on the balance sheet.
Citi’s price targets
“We believe Sprint can create meaningful value through a merger scenario with T-Mobile US Inc (NYSE:TMUS), but the regulatory hurdles won’t be easy to clear. We are raising our Sprint target to $8.50 and raising our target on T-Mobile at $28,” say Citi.