Deutsche Telekom in arranged marriage for T-Mobile USA through reverse acquisition by MetroPCS
Deutsche Telekom is leading its daughter T-Mobile USA down the aisle for a second time in less than two years after the previous marriage attempt with AT&T collapsed in light of regulatory objections (see http://goo.gl/hgCrm). But T-Mobile USA will not leave the house altogether. Should the deal go through, Deutsche Telekom will own 74% in the NewCo. The NewCo will operate as one company with two brands, similar to how Everything Everywhere was run. MetroPCS Shareholders will own the remaining 26%.
The financial plan is that scale effects will translate into $6-7 billion of cost synergies from enhanced scale and scope. Deutsche Telekom pitches the deal as creating a wireless value leader in the non-contract (pre-paid) segment, with the goal of targeting a growing market segment. The ambition for the NewCo is to generate compound annual growth rates of 3-5% for revenues, 7-10% for EBITDA and 15-20% for free cash flow over the next five years.
The deal raises several issues for me:
- Targeting a market opportunity requires ongoing investments. In my view, the goal for growth looks ambitious based on the proposed value proposition. Whilst I do see a market opportunity for unlimited data plans (i.e. NewCo’s value proposition), I believe that ongoing investments beyond the existing ones are required to ensure QoS and customer experience. The completed network modernization to the tune of US$4 billion LTE investment including site upgrades and spectrum re-farming provides a good starting point. But more capex is required in the years ahead as data traffic continues to explode. In turn, this could undermine free cash flow growth ambitions.
- Scale is always relative. Scale will provide the NewCo with access to some of the more popular handsets and network cost benefits. The NewCo will also be a leader in terms of revenues in the pre-paid segment. But the combined entity will have 42.5 million subscribers (33 million T-Mobile USA; 9 million MetroPCS), leaving it still a number four provider, behind Verizon Wireless (105 million), AT&T (105 million) and Sprint (56 million). Moreover, Sprint might team up with Leap Wireless to counter any shift in the balance of power, or even make a counter-bid for MetroPCS.
- Change offers the opportunity for experimentation. I see a risk that the NewCo is run as just another low-cost and boring provider. In my view, Deutsche Telekom should treat the NewCo as a test bed for carrier business model innovation, especially regarding over-the-top and wholesale services. Network agnostic communications services like T-Mobile’s Bobsled are an interesting and necessary first step towards business model transformation (see report The Future of Over-The-Top-Services). Embedded connectivity for devices and apps should become a focus area for the NewCo going forward.
T-Mobile USA – MetroPCS is a marriage of reason not passion. Deutsche Telekom’s second marriage attempt for its daughter looks a lot less glamorous than its first with AT&T. There certainly will not be billions of cash commitments flowing towards necessary investments in Deutsche Telekom’s domestic network infrastructure. The €7-8 billion goodwill impairment on T-Mobile USA that is expected to be booked for 4Q12 as part of the deal underlines the different context Deutsche Telekom is facing. The hope remains that T-Mobile USA will increasingly look after itself as Deutsche Telekom’s management attention needs to focus to its home market where many other challenges remain.