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The Telecommunications Services industry is highly competitive, particularly in the wireless segment. A wireless carrier with a solid brand, substantial scale, a broad network reach, ample spectrum, an attractive mobile device lineup, competitive pricing plans, and a solid reputation for service quality is well positioned to expand its subscriber base, boost operating results, and reward investors with better-than-average total returns. AT&T (T - Free AT&T Stock Report) is attempting to bolster its well-established position in the market via the purchase of T-MobileUSA. The telco faces a tough regulatory review and significant industry opposition. If the deal is approved, AT&T’s peers would likely join forces to better compete against a much bigger sector leader.

At the end of the March 2011 quarter, Verizon Wireless, a joint venture between Verizon Communications (VZ - Free Verizon Stock Report) and Vodafone Group (VOD), having a total 104 million subscribers, was the largest wireless carrier in the U.S. AT&T, with 97.5 million accounts, held second place, followed by Sprint Nextel (S), which had 51.0 million customers, and T-MobileUSA, a Deutsche Telekom (DTEGY) subsidiary, with an account base of about 33.5 million. For $39 billion in cash and stock, AT&T would get T-Mobile and capture the top industry spot, with 131 million subscribers. Deutsche Telekom would maintain a minority stake (less than 10%) in T-Mobile.

Overall penetration of the domestic wireless market is now very close to 100%. Population growth and people opting to own more than one phone present some growth opportunities but not as great as the pace of past years when wireless service was new. Expanding demand for data offerings (e.g., movie, gaming downloads) is a plus. Still, more and more, the telcos are fighting for market share, rather than new business.

A number of sizable, successful acquisitions made during the past two decades has given AT&T a broad national network. The company has the scale and financial wherewithal to secure favorable agreements with suppliers of services, equipment, and devices. Most notable was a pact with Apple Inc. (AAPL) for AT&T to be the first exclusive provider of service utilizing the iPhone. This device proved so popular, that the telco has had problems managing network capacity and sustaining high-quality connections. T-Mobile offers the ability to optimize usage of existing spectrum. Also, management estimates it will garner some $40 billion in operating cost savings.

Among the competing U.S. wireless carriers, Sprint Nextel has been the most vocal in its opposition to the merger. Low-cost service providers Leap Wireless International (LEAP) and MetroPCS (PCS) are concerned about the deal’s impact on competition, as well. Sprint is worried that a duopoly would be created, with AT&T and Verizon Wireless having too great of a market advantage. The telco says that an AT&T/T-Mobile combination would eliminate a significant price competiton, slow technology advancement, and, among other negatives, cause a sizable reduction in employment. AT&T believes the deal would be beneficial to customers and points to the support of various tech companies, labor unions, and state governors as validation of its viewpoint.

The proposed acquisition must pass reviews from the U.S. Department of Justice (DOJ), the Federal Communications Commission (FCC), and the Securities and Exchange Commission. Given the sluggish pace of the current economic recovery, we expect the DOJ and FCC to be especially mindful of the deal’s impact on the economy and possible antitrust issues. Congress and several states, including California, Connecticut, Minnesota, New York and Louisiana, intend to weigh in on the review process. AT&T is lobbying authorities heavily in an effort to close the merger within a year.

AT&T’s peers are already feeling the heat. Sprint, primarily aiming to take business from T-Mobile, recently offered a $175 one-time credit to customers switching from competing networks to its own. T-Mobile has countered with a similar $200 proposal. Before AT&T announced its pact to buy T-Mobile last March 20th, Sprint had approached the Deutsche Telekom operation about a combination. Given the prospect of a bigger AT&T, Sprint may well find itself a takeover target for Verizon Comm. or CenturyLink (CTL), comprised of the former CenturyTel and Qwest Comm. businesses.

Additionally, Sprint may find a combination with MetroPCS or Leap Wireless attractive. Metro and Leap, themselves, feel the pressure to build scale, and appear open to bidding on any assets that regulators might require AT&T and T-Mobile to divest in order to complete their deal. (Note that AT&T has agreed to pay Deutsche Telekom a $3 billion breakup fee, if, under certain conditions, the transaction falls through.)

AT&T shares have performed fairly well in the interim since the merger agreement was announced. We believe that regulators will approve the combination, but not without meaningful divestitures and, possibly, some regulatory concessions. Investors should be aware, though, that cancellation of the acquisition could temporarily pressure AT&T’s stock price. Those who are venturesome, might want to take a stake in MetroPCS, which, as we have stated above, is a potential buyout target.

 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.