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AT&T (T - Free AT&T Stock Report), with roots tracing back more than 100 years, has grown to become one of the world's largest telecommunications companies by being aggressive on the M&A front. But the Dallas-based carrier's recent bid, announced this past March, to shake up the domestic wireless market by purchasing T-Mobile USA from Deutsche Telekom AG has been met with considerable resistance. In fact, in a rare and unexpected (certainly to AT&T management) move, the U.S. government has sued to block the $39 billion cash-and-stock transaction on antitrust grounds.

The Justice Department argues, in a complaint filed in the U.S. District Court for the District of Columbia, that the proposed tie-up would leave too few national players and, ultimately, force consumers to pay higher prices for increasingly important mobile voice and data services. The pace of innovation would also slow, according to the government, without an independent T-Mobile around to light a fire under its larger rivals. T-Mobile, the first carrier to introduce a coast-to-coast high-speed data network, has long had a reputation for being a cutting-edge service provider.

The U.S. wireless industry is certainly top-heavy, as the Justice Department rightly points out. The four biggest nationwide carriers, including leader Verizon Wireless (with an approximate market share of 35%), AT&T (32%), Sprint Nextel (S) (15%), and T-Mobile (12%), now account for about 94% of all wireless connections in the country. (Verizon Wireless is a joint venture between Verizon Communications (VZ - Free Verizon Stock Report) and British outfit Vodafone Group Plc (VOD).) Moreover, they are poised to leave the sector's smaller regional players, such as Leap Wireless (LEAP) and MetroPCS (PCS), farther in the dust by broadening the reach of their networks and lining up exclusive deals for popular smartphones and tablet PCs.

Consequently, a merger between AT&T and T-Mobile, if approved, would certainly be a case of "the rich getting richer" (AT&T's market share would swell to roughly 44%), and leave an even smaller group of national carriers for America's consumers to choose among. This may or may not be cause for alarm, depending on which arguments you support. AT&T, in opposing the government's case, insists that the merger will actually serve the public interest, since the acquired wireless bandwidth, or spectrum, will enable it to roll out more next-generation, high-speed data services and further improve the quality of its network.

But an AT&T/T-Mobile union would most definitely oust Verizon Wireless, which may feel compelled to pursue extra wireless bandwidth and/or its own accretive acquisition, from its position as king of the wireless mountain. And it would put more pressure on Sprint Nextel, already struggling to compete and operating deep in the red.

Indeed, Sprint, which has petitioned the Federal Communications Commission to block the deal for T-Mobile (the FCC, while reviewing the matter, is unlikely to rule on the proposed merger until the Justice Department's case reaches a conclusion), would be a distant No. 3 player in the U.S. wireless market if AT&T gets its way. Combined, AT&T and Verizon would control nearly 80% of the space, a virtual duopoly. This would provide OEMs around the world with little incentive to produce devices for other carriers like Sprint that have relatively small consumer footprints. And an AT&T/Verizon duopoly would make it even more difficult for Sprint's attractively priced service packages to gain traction in the marketplace.

For its part, AT&T has a fair amount to lose if the T-Mobile acquisition falls through. Aside from missing a chance to overtake Verizon, shore up its network, and realize greater economies of scale, the company stands to lose a hefty breakup fee worth an estimated $7 billion. Pursuant to the merger agreement, AT&T would have to give Deutsche Telekom and its T-Mobile USA unit $3 billion in cash, along with discounted roaming rates and some wireless spectrum, if the deal is not consummated. That said, we would still view AT&T favorably even without the addition of T-Mobile.

The carrier's existing mobile business continues to grow at a rapid pace, as more consumers trade up from tradition cellular phones to smartphones (e.g., the iPhone) and tablet computers in order to enjoy the latest high-bandwidth video and data products. What's more, wireless margins are poised to widen with the help of network-rationalization efforts and enhanced customer service. And the company would, we think, have plenty of other opportunities down the road to purchase additional spectrum and expand its service capabilities.

All in all, we think that Sprint has the most to lose if the T-Mobile merger eventually gets green-lighted, while AT&T clearly has the most to gain. AT&T and Verizon will probably remain the sector's two biggest winners either way, however. As such, irrespective of whether AT&T bests the Justice Department in court and buys T-Mobile (it appears too close to call at present), we think that most investors would do well to stick with these high-quality names. Shares of both AT&T and Verizon Communications should provide investors with good risk-adjusted returns over the pull to 2014-2016. And, since both companies pay generous dividends, these telecom stocks are suitable for more conservatively managed, income-oriented accounts.

 

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