Sprint’s (NYSE: S) stock price was down 14%, and T-Mobile’s (NASDAQ: TMUS) stock price was down 6% the first trading day following the announcement of the proposed merger. Based on the market’s reaction, it seems that Sprint and T-Mobile are the only entities excited about the proposal.
The merger news reminded me of a good old school R& B playlist because I found myself asking “What’s going on?”, “Where do we go from here?” because I had a little feeling of De ja vu since “[we’ve] been here before.” I encourage you to ponder these points before purchasing either stock in anticipation of the merger.
What’s going on?
On Sunday, April 29, 2018, Sprint and T-Mobile entered into a Business combination agreement, commonly known as a merger, which is expected to close (subject to regulatory review and closing conditions) during the first half of 2019. The merger would create a new company, T-Mobile run by current T Mobile CEO, John Legere.
The German telecommunications giant, Deutsche Telekom, currently owns 63.5% of T-Mobile stock with the remaining 37.7% owned by the public. SoftBank Group Corp, a Japanese multinational conglomerate with holdings in Uber and Alibaba, owns 84.8% of Sprint common stock. The remaining shares are owned by the public.
How to Pick your first stock
T-Mobile and Sprint will create the new company by merging their interests in an all-stock transaction. An all-stock transaction requires a pre-set stock exchange ratio. Here, the exchange ratio is 0.10256 of a T-Mobile share for each Sprint share (or 9.75 Sprint shares for 1 T-Mobile share). As a result of this merger, the new T-Mobile will assume ownership of both companies’ assets and liabilities which includes a total debt obligation of over $75 billion.
Where do we go from here?
The merger is expected to close in the first half of 2019 pending federal regulatory review, which among other things, includes a determination if the transaction is in the public’s best interest. If the merger is completed, the resulting ownership allocation of the new T-Mobile will be 42% Deutsche Telecom, 27% SoftBank and 31% public shareholders.
The merger requires a PLR Agreement between the companies including the requirement that SoftBank to vote its shares as directed by Deutsche Telekom. The terms also have a “lock-up agreement” preventing either company from transferring its T-Mobile shares for four years after the closing date of the merger. Finally, if T-Mobile terminates the agreement after the terms of the deal are satisfied, T-Mobile will be required to pay Sprint $600 million.
De ja vu [we’ve] been here before
T-Mobile has been an acquisition target for over seven years. In 2011, it was set to merge with AT&T as part of a $39 billion deal that was stopped by an anti-trust lawsuit filed by the Department of Justice (“DOJ”). In 2014, Sprint abandoned a $32 billion deal to acquire T-Mobile amid concerns regarding the deal’s inability to pass through federal regulators. At that time, the head of the DOJ’s Antitrust Division stated, “[i]t’s going to be hard for someone to make a persuasive case that reducing four firms [AT&T, Verizon, Sprint, and T-Mobile] to three is actually going to improve competition for the benefit of American consumers.”
A lot has changed since 2014. Sprint has lost its bargaining power as it is burdened by a significant amount of debt. T-Mobile has emerged as a formidable player—its market capitalization is $51.37 Billion, which is over double Sprint’s market cap.
Additionally, the new administration might be more open to approving the deal. In 2017, Sprint hired a lobbying firm with close ties to the Trump Administration to assist with approval. T-Mobile’s CEO Legere directly addressed the 2014 regulatory concerns in the April 29, 2018 press release by citing the “compelling benefits” of the merger. He states, “This isn’t a case of going from 4 to 3 wireless companies – there are now at least 7 or 8 big competitors in this converging market. And in 5G, we’ll go from 0 to 1.”
Unfortunately, the “compelling benefits” are not so compelling. The press release reads like “Make America Great Again” propaganda, which is a curious stance considering Sprint and T-Mobile and the proposed new company will remain majority foreign-owned. The press release highlights that the merger will drive “significant U.S. Job Growth” inside and outside of the new company. The new company expects to invest $40 billion into its 5G network and business in the first three years. The contention that T-Mobile’s increased growth will spur other major telecommunication companies to spend billions of dollars in investment to compete is merely conjecture, at best.
The companies believe the nationwide 5G network will provide the “breadth and depth needed to enable U.S. firms and entrepreneurs to continue to lead the world in the coming 5G era, as U.S. companies did in 4G (emphasis added).” However, around the time of merger talks between the two companies four years ago, SoftBank CEO Masayoshi Son stated, “the United States’ mobile industry is not competitive compared with other countries.” He also complained, “[e]very time I make a business trip to the U.S., I am reminded how terrible connections are there.” So the claims about leading the world in this space are more of the fake news that we’ve come to expect from this Administration.
Conclusion
The merger announcement reveals important two things regarding each company. First, it exposes Sprint’s poor financial health as evidenced by its massive debt. A condition of this merger highlights this concern—Sprint is required to maintain a minimum credit rating. Second, no amount of fake news can overshadow the fact that neither company alone “can create a nationwide 5G network with the breadth and depth required” to support “mobile Internet innovation in the US and answer competitive challenges from abroad.”
T-Mobile and Sprint contend that their merger will “disrupt the marketplace and lay the foundation for U.S. companies and innovators.” Admittedly, many businesses use the term “disruption” to describe a speculative outcome but combining a network with the Internet of Things (IoT) capabilities might be the necessary “disruption” this industry needs. However, the dip on Monday indicates that the market is not convinced that this deal will pass through regulators. Although the agreement has a higher probability of passage (with some changes) than the market believes, refraining from purchasing either company until the federal regulators’ determination make their determination is a good idea.