AOL, Economics

T-Mobile, Sprint Mull Merger In Bid To Survive Price War

It was meant to be the year of massive dealmaking for US telecoms as a regulatory ban on M&A was lifted. Things didn’t live up to the hype after the big wireless spectrum auction ended, however, and investors balked as a punishing price war set in.

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Just last week, Verizon CEO Lowell McAdam made it clear that his company, the largest wireless carrier in the US, will have nothing to do with cable deals. Thus, no hotly anticipated takeover of Charter Communications. (That privilege could go to Altice thanks to the French telecom's willingness to take on seemingly endless debt.)
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But thanks to T-Mobile CEO John Legere and counterpart Masayoshi Son, CEO of Sprint parent company SoftBank, things are heating up. The two sides have reportedly opened active negotiations about an all-stock merger, and the German parent of T-Mobile, Deutsche Telekom, would reportedly have control.

If completed, the deal would combine the third and fourth largest wireless carriers in the US, and for a beleaguered industry, the move can't come soon enough. Although the combination of T-Mobile and Sprint was abandoned in 2014, the world around the Big Four has changed massively since.

Here is a look at slowing telecom M&A activity in the "quad play" space —landline phone, TV, broadband and wireless:

T-Mobile, Sprint Merger

Price war intensifies

"Post-paid" subscriber growth for wireless carriers has stalled in recent years as the smartphone market has reached saturation. With the pie of new business no longer expanding, companies have embarked on an increasingly desperate race to the bottom, competing on price to pry customers away from rivals by offering free data, free phones, free taxes and deploying tactics like Sprint using Verizon's "Can you hear me now?" guy in advertisements.

The result is a downright frightening bout of wireless-plan price deflation, as shown in the chart below, which is pulling down economy-wide telephone services prices by roughly 9% YoY. A dynamic that caught the eye of the US Federal Reserve as it considers the pace of interest rate hikes.

Revenue growth has subsequently stalled. Verizon's sales have declined 4% on average in each of the last six quarters. AT&T has seen negative revenue growth in each of the last three. Meanwhile, Sprint and T-Mobile are seeing setbacks, as well, after enjoying gains relative to the top two players. Sprint's revenue growth slowed to just 1.8% YoY last quarter compared to 5.8% previously. T-Mobile's growth slowed to a still-impressive 10% compared with 23% in 1Q.

As a result, investors have turned away. The iShares US Telecommunications ETF—which holds stakes in all four major wireless carriers—had fallen nearly 20% from its early 2017 high, this after rising 40% from its January 2016 low on hopes that media acquisitions would boost earnings power.

Instead, the center of AT&T's and Verizon's business came under fire from their smaller rivals; the majors responded with in-kind promotions and discount activity; and, now, the fire fueling that competition threatens to burn them all. AT&T and Verizon can ill afford earnings pressure resulting from price-driven revenue declines because of the debt they accumulated to fund earlier M&A escapades, including the $23 billion AT&T raised earlier this year.

Hope springs anew, however, on the hopes a T-Mobile-Sprint combination will bring some price discipline to the marketplace: T-Mobile (NASDAQ: TMUS) gained 5.9% while Sprint (NYSE: S) jumped 6.8% on Tuesday.

Article by Adam Putz, Anthony Mirhaydari - PitchBook