Analysis: AT&T's Buyout of T-Mobile USA has Big Problems

Only one major telecom merger has been blocked in the last decade: DirecTV was trying to merge with Dish in 2002. Many are predicting AT&T's purchase of T-Mobile USA could become the second failure.

Over at the blog Tales of the Sausage Machine, Harold Feld has an interesting analysis of the proposed buy out. Feld is Legal Director of Public Knowledge which is a non-profit, public-interest advocacy organization. We first met Feld at a panel discussion presented by The Media Access Project Innovation 08 called Spectrum Policy After the 700 MHz Auction. Feld has been a very vocal in his opposition to AT&T's buyout of T-Mobile USA since it was announced in March.

AT&T has been trying to sell the idea that there is a radio spectrum shortage for wireless phones. However, Jon Healey of the LA Times wrote an article in April "Spectrum crisis? What spectrum crisis?". Healey explained AT&T's deal "would eliminate one of the four largest US mobile phone networks and leave just two companies - AT&T and Verizon Wireless - in control of more than 70 percent of the market." Cisco did a projection that shows the "demand for mobile bandwidth will increase at a slower and slower rate in the coming years, as the penetration of smartphones slows."

Feld explains that AT&T originally assumed all the regulatory agencies would roll over and let them buy T-Mobile USA. Things appeared to be moving along in AT&T's favor until early August when AT&T attorneys mistakenly sent an incriminating internal document to the Federal Communications Commission (FCC). The unredacted internal letter says AT&T could spend $3 billion to $5 billion and provide true fourth generation - LTE (Long Term Evolution) coverage to 95 percent of the USA, instead of buying T-Mobile USA and paying $39 billion. This killed AT&T's key talking point with regulators and the press. AT&T claimed that they need T-Mobile to increase LTE network coverage from 80 percent to 97 percent of the population.

Then on August 30th a US Department of Justice (DoJ) launched an anti-trust lawsuit. Along with DoJ's anti-trust suit are seven state Attorney Generals who are objecting with their own lawsuits. James Cole, DoJ's deputy attorney general, said: "We feel the combination of AT&T and T-Mobile would result in tens of millions of consumers across the US facing higher prices, fewer choices, and lower quality products for wireless services."

The DoJ complaint notes that the merger leads to unhealthy levels of concentration in 97 of the top 100 Standard Metropolitan Statistical Area (SMSA) markets. The Yankee Group analyzed the DoJ anti-trust suit assumptions and created a series of charts.



How the market share looks today.

All along AT&T has been applying a lot of lobbying pressure on Congress. On September 20th, 100 House Republicans signed a letter urging the Obama Administration to resolve the DoJ anti-trust lawsuit and let AT&T buy T-Mobile USA. Research shows that 99 of those 100 Republican Congressmen have received political donations from AT&T lobbying efforts since 2009, according to a Bloomberg review of campaign finance records. The article says AT&T lobbying has given $963,275 to those US lawmakers who are urging approval of the T-Mobile USA deal.

The Republicans are not alone in asking President Barack Obama to direct the Justice Department to settle this antitrust lawsuit. All 15 of the Democratic lawmakers, who signed their letter the same week as the Republicans, have benefited from AT&T’s lobbying money. In the 2010 election cycle, these Democratic lawmakers, were lobbied to the tune of $141,5000. Thus, AT&T has spent at least a million dollars attempting to influence Congress. More specifically to have Congress influence the President to make the US DoJ quickly settle their anti-trust lawsuit against AT&T's buyout of T-Mobile USA.

The legal complications of the DoJ anti-trust lawsuit has become the first giant hurdle AT&T must overcome before the buyout can take place. The DoJ lawsuit is tied to the Tunney Act which sets forth procedures that must be followed whenever the United States proposes to settle a civil antitrust suit through entry of a consent decree. That means to settle any anti-trust case requires the approval of a federal judge and demonstration that it's in the public interest.

Most legal experts say presidents have the authority to intervene in anti-trust cases on foreign policy or national security grounds. However, it would be very unusual for any president since Richard Nixon to attempt ordering the DoJ to drop an anti-trust case on economic grounds. In 1971, Mr. Nixon issued an order that allegedly came after ITT agreed to secretly donate $400,000 to Nixon's campaign. The Tunney Act was passed because of the ITT - Nixon scandal.

The FCC, which oversees the wireless industry, is in the midst of its own review of the proposed merger, in part because of getting a copy of AT&T's unredacted internal letter plus the DoJ's anti-trust lawsuit announcement. FCC Chairman Julius Genachowski said that the agency also believes the merger raises "serious concerns about the impact... on competition."

The Yankee Group chart below shows analysis for 27 of the most popular CMA's (Cellular Market Areas). Yankee Group authors said: "Today, AT&T has 37 percent or more of the subscribers in nine of those CMA's. The proposed merger would give AT&T more than 33 percent of the market in the 20 of those 27 markets. In fact, the merger with T-Mobile would give AT&T a full 50 percent market share or more in five of the most popular CMA's."


Market concentration before and after

Feld offered several options for AT&T to unwind themselves from their legal problems. He explained it this way: First would be set up a new national carrier, effectively a "T-Mobile Lite". Then AT&T would "also make divestitures in the top 20 markets, not merely the middle markets, and offer roaming conditions in the major markets so open they might as well be wholesale. As an added bonus, under the new data roaming rules, whatever roaming deal AT&T gives its' T-Mobile Lite' it needs to give everyone else as well. Finally, keep in mind AT&T can't just divest licenses. They will actually have to give up market share by transferring customer accounts to the new "T-Mobile Lite".

Feld believes this scenario would seriously affect AT&T's market cap and share value. It raises the question of who on Wall Street will loan the money to buy T-Mobile USA and provide the start up funding for the so-called T-Mobile Lite? Since today's bond interest rates are at an all time low, AT&T will have to pay a significant premium to get new money. Plus, the bonds would be from T-Mobile Lite, as a start up company with no track record, instead of the historically sound AT&T.

Feld believes that AT&T's past legendary willingness to ignore regulatory restrictions – such as AT&T and Dobson Wireless or AT&T and MediaOne Group to name just two examples of many – are major problems. The FCC is nearly a 'toothless tiger' when it comes to enforcing restrictions on any communications industry consolidations. AT&T's track record would mean the federal judge reviewing the DoJ's August Tunney Act anti-trust lawsuit should have serious reservations about any settlement plan.

The wireless industry has been full of rumors that AT&T will find a partner. MocoNews asked this: "AT&T has argued for months that the US wireless market is competitive, but competitive markets don’t usually prompt leading players to consider selling of their most prized assets to smaller competitors. After all, if the world is truly competitive, why would you want to give your competitors any kind of help?"

The US DoJ uses a more sophisticated analysis, the Herfindahl-Hirschman Index (HHI), to assess market concentration. Yankee Group used the HHI Index and found "if the merger goes ahead 17 or 63 percent of the 27 markets would be highly concentrated. Not only would 17 of the top 27 CMA's become more highly concentrated, but the HHIs would jump dramatically. The DOJ's 2010 guidelines state that any HHI increase of 200 points or more is considered significant. In our analysis, not only did 25 of the 27 CMA's see HHI increases over 200 points, but four of the CMA's had HHI increases of over 1000 points. There is no question the merger would result in significantly more concentrated markets."


Post merger concentration increases in 27 markets. Source: Yankee Group

Sprint is too large a competitor to partner with AT&T. Plus, they have embarked on a $10 billion consolidation of their multi-frequency wireless networks. That leaves CenturyLink, Dish Network, MetroPCS, Leap, and US Cellular as the possible partners. Of these, MetroPCS is the largest wireless carrier and the one most often whispered to be in "deep discussions" with AT&T. [BSN* thinks the whisperings are often planted stories by AT&T publicity dept. Ed.]

A major problem for one of the minor players to partner with AT&T/T-Mobile USA would be to handle the instant growth. They would have to take over a lot of the customers, handle new radio frequencies and new cell towers, and add back-haul network. All this would need a large pile of cash to pay for the expansions. There are also staffing problems when doubling or tripling their organization size along with the usual employee retention problems when there is effectively a take over.

Sprint nearly lost control of their customer base when they merged with Nextel in 2005. Plus, Sprint is just now showing their plans on how to take advantage of the Nextel spectrum and not lose more of their Nextel PTT (push-to-talk) business and public safety customers. Sprint has been working on their LTE expansion plans for the past year and a half. They put out RFPs for necessary equipment in December 2010. Just a few weeks ago they showed their plans to analysts and immediately had their share price drop, because Wall Street questioned their technology solutions and their ability to finance the planned multi-frequency system.

This bring us back to MetroPCS as a possible partner. Last winter BSN* tested MetroPCS' network in the Sacramento, CA area. To be polite, it was not a very robust system. Because the carrier's network is the AWS 1700 to 1750 MHz spectrum with 5 Mhz-by-5MHz bandwidth, they cannot compete with Verizon's 4G LTE network in over 170 cities.

Tom Keys, chief of operations for MetroPCS said: "We didn't build this network or this device to be all things to all people. We did this is in a very methodical fashion. We didn't try to get everything in the beginning."


MetroPCS 4G uses AWS 1710 to 1755MHz spectrum

On the other hand, Verizon has MHz of nationwide contiguous spectrum bandwidth – 10MHZ-by-10MHz downlink-uplink:


700MHz Analog TV spectrum, now to be used for 700MHz LTE Deployment by Verizon Wireless and AT&T, as well as T-Mobile USA

Industry analysts estimate it would take $2 billion to $3 billion to build out the MetroPCS network to handle the majority of those 97 markets where competition would be restricted by the AT&T/T-Mobile USA buyout.

That’s in the same ballpark as the AT&T redacted letter estimated it would cost for them to cover 95 percent of the USA. Plus, AT&T would then have helped create T-Mobile Lite into something which is probably an equal to Sprint. Effectively, the new T-Mobile Lite would potentially steal from AT&T.

On September 28, the CTO of German telecoms group Deutsche Telekom (DT), Olivier Baujard, spoke at the Broadband World Forum conference in Paris. DT is parent company of T-Mobile USA. He announced that DT was reconsidering their ten billion Euro investment for German expansion plans. During a sideline discussion, he was asked about their plans for T-Mobile USA. He said that "that any rational company had a Plan B and that Deutsche Telekom had other opportunities for its US operations should the US Department of Justice succeed in terminating the deal".

DT is not going to allow T-Mobile USA to crash and burn. Clearly, T-Mobile USA has value to other purchasers besides AT&T. The rumors are that last year there were four or five possible suitors. AT&T is in hock for $6 billion to T-Mobile USA if the buyout deal cannot happen by March of 2012. [That money would make T-Mobile USA very competitive. Ed.]

AT&T originally sold this buyout idea to Wall Street analysts as a win-win for everybody. As time marches on, the capital needed to make it work has steadily grown. The regulators, the judiciary, public advocates, the press, the public, and the unpaid-for-Congressmen are all rethinking that original AT&T sales pitch.

Feld points to the Yankee Group study which says if the deal goes through, regulators will tighten their controls on the remaining major wireless carriers. That means it will cost more to stay competitive with the smaller carriers. When you say expenses are gonna go up and profits will go down, Wall Street will start to back away from a deal.

Yankee Group analysis of the DoJ HHI anti-trust suit information shows that prices will increase in seven of nine CMAs. It is safe to estimate that T-Mobile’s 36 million customers will rapidly see higher monthly rates similar to what AT&T's 97.5 million customers are now paying.


Prices go up in 7 of 9 CMAs. Source: Yankee Group

T-Mobile USA will see a drop off over time from their present 36 million customers to slightly more than 10 million. That will be an unpleasant prospect for parent company DT.


Should the acquisition go through, by 2015 T-Mobile USA is expected to significantly lose market share

Obviously, AT&T CEO Randall Stephenson and DT CEO Rene Obermann have staked a lot on the deal coming through as agreed upon last winter. They have spent a lot of shareholders’ money and political capital, not to mention their personal reputations are on the line too. AT&T clearly had no intention of paying $6 billion to T-Mobile USA / Deutsche Telekom when they jumped into this high stake poker game. We bet neither of them want to be remembered as the guys who lost an anti-trust fight, the first in over a decade.

BSN* agrees with Harold Feld's final analysis: "... in the end, it may be Wall St[reet] rather than DoJ or the FCC that finally pulls the plug on what has become an expensive and destructive personal crusade by corporate executives unwilling to admit they bet wrong and with the freedom to spend shareholder money like water rather than own up to a mistake."