AT&T Paying Twice Valuation for Customer-Losing Firm at 29 Times: Real M&A

AT&T Inc. (T) is so determined to surpass Verizon Wireless that it’s willing to pay double its own valuation for the only U.S. wireless operator losing customers.

AT&T agreed to buy T-Mobile USA on March 20 for $39 billion in cash and stock and create the largest U.S. mobile-phone company, valuing Deutsche Telekom AG (DTE)’s unit at 28.8 times earnings, according to data compiled by Bloomberg. AT&T, which fell 31 percent even after it began exclusively carrying Apple Inc.’s iPhone in June 2007, now trades at 13 times profit, while Verizon Communications Inc. (VZ) commands a multiple of 16.3. T- Mobile’s valuation was also higher than any cellular phone company outside Hong Kong and China, the data show.

Chief Executive Officer Randall Stephenson, 50, is betting that adding T-Mobile USA’s 34 million customers and wireless spectrum will boost sales and reduce dropped calls after losing exclusive rights to the iPhone. The Dallas-based company is spending what Deutsche Telekom’s finance chief called an “enormous” price that avoids taking on T-Mobile USA’s $15.9 billion of debt and may ward off other suitors. The deal still faces regulatory hurdles and a $3 billion breakup fee if it falls apart.

“Is T-Mobile that much more valuable? I doubt it,” said Malcolm Polley, who oversees $1 billion as chief investment officer at Stewart Capital in Indiana, Pennsylvania. “It’s a struggling company. If AT&T has to sell big chunks of the thing to make it work, it doesn’t make sense. If they can’t complete the deal, they’ve got to turn over $3 billion.”

High-Speed Wireless

Shares of AT&T rose 1.2 percent to $28.26 yesterday after announcing the deal that will help expand the rollout of its high-speed wireless technology. Deutsche Telekom jumped 11 percent to 10.67 euros yesterday after it sold the unit for more than analysts projected. The Bonn-based company advanced 0.6 percent to 10.73 euros today.

AT&T and T-Mobile USA combined would control 39 percent of the U.S. mobile-phone market, surpassing Verizon Wireless, which has 31 percent, according to data compiled by research firms EMarketer and ComScore Inc.

The transaction will give AT&T new airwaves for its planned high-speed, fourth-generation network that will cover 95 percent of the U.S., John Stankey, president of AT&T Business Solutions, said on a conference call yesterday. AT&T and T-Mobile in the U.S. both use the GSM standard to deliver mobile phone and data service, making the integration easier, he said. The combined company will also be able to cut costs in retail, advertising and overhead.

‘Liking the Deal’

“The market seems to be liking the deal,” said E. William Stone, who oversees about $105 billion as chief investment strategist in Philadelphia for PNC Wealth Management, which owns shares of AT&T. The company believes they can “take a lot of costs out of it,” he said.

AT&T will be able to increase average revenue per user by selling more data-heavy smartphones to T-Mobile USA customers and reduce T-Mobile USA’s cancellation rate with a bigger lineup of phones, improved network performance and access to Wi-Fi hotspots, Ralph de la Vega, CEO of AT&T’s mobility and consumer markets, said on the conference call.

Last year, AT&T said it had a so-called churn, or cancellation, rate of 1.3 percent compared with T-Mobile USA’s 3.4 percent. AT&T drew an average of $62.57 from each customer, while T-Mobile USA got $52, according to AT&T’s slide presentation yesterday.

‘Really Look’

AT&T was the only U.S. carrier selling the iPhone until Verizon Wireless got the device this year. The smartphone, which downloads music, videos and accesses the Internet, clogged AT&T’s network in markets such as New York and San Francisco, causing dropped calls and hurting customer satisfaction ratings. AT&T needs acquisitions to boost profit that it could then invest in its network and service, said Bill Kavaler, a special situations analyst at Oscar Gruss & Son Inc. in New York.

“You can’t really look at it in terms of being cheap or expensive,” Kavaler said. “You have to look at it in terms of competitive position. Now that Verizon has Apple’s products, AT&T’s biggest problem, which was their coverage and their quality of service, perceived to be inferior to Verizon, is now an issue.”

While AT&T won more customers since it started selling the iPhone, its shareholders haven’t reaped the benefits. Since the phone’s debut in June 2007 -- the same month Stephenson became AT&T’s CEO -- the company’s shares declined 31 percent through last week. Over the same span, New York-based Verizon dropped 6.2 percent, according to data compiled by Bloomberg.

‘Ends Any Debate’

Including dividends, AT&T dropped 16 percent, versus a 15 percent return for Verizon. Only two integrated telephone companies with market values of more than $10 billion lost more shareholder value in that period than AT&T, the data show.

AT&T, the second-biggest U.S. wireless provider, beat out Sprint Nextel Corp. (S) by agreeing to pay $25 billion in cash and offering a higher-than-average breakup fee, said three people with knowledge of the matter. Overland Park, Kansas-based Sprint and Deutsche Telekom had held on and off discussions about a lower priced deal for T-Mobile USA, according to the people, who declined to be identified because the negotiations were private.

“That ends any debate about it as far as somebody else coming in and making an offer,” Peter Sorrentino, who helps oversee $14.4 billion at Huntington Asset Advisors in Cincinnati, said of the price AT&T is paying for T-Mobile. “It ends all debate.” Huntington owns AT&T shares.

In T-Mobile USA, AT&T is getting a business that reported profit declines in four of the past five years as it trailed U.S. rivals in building out a third-generation mobile network and missed out on sales of the iPhone. About 56,000 customers abandoned T-Mobile last year, while Verizon Wireless, AT&T and Sprint all boosted their subscriber counts.

‘Enormous Price’

AT&T agreed to pay a breakup fee of $3 billion, or almost 8 percent of the total purchase price, which is more than twice the typical fee. The company also will give Deutsche Telekom some spectrum if the deal falls through.

Deutsche Telekom’s Chief Financial Officer Timotheus Hoettges said the deal topped analysts’ estimates for T-Mobile to fetch 16 billion euros ($22.7 billion) to 19 billion euros in an acquisition.

“With this enormous price, we’ll be able to more consistently improve, change and renew our strategy,” he said on a conference call with reporters yesterday.

Completing the acquisition may still take a year, the companies said. Regulators may force AT&T to build out more rural networks or provide data roaming to rural carriers, said Roger Entner, an analyst at Recon Analytics LLC. AT&T expects regulators will require it to divest wireless spectrum and subscribers, said a person with knowledge of the situation.

Relative Value

The $39 billion price tag is 28.8 times T-Mobile USA’s net income of $1.35 billion last year, according to data compiled by Bloomberg. T-Mobile USA’s earnings slipped 7.9 percent in 2010 as sales declined for a second straight year.

The valuation was 121 percent higher than AT&T’s price- earnings ratio, 77 percent greater than Verizon and 5.3 percent pricier than Deutsche Telekom, data compiled by Bloomberg show. It’s also more than twice the median valuation of 11.9 times profit as of last week for 32 global cellular phone companies with market capitalizations of more than $1 billion, excluding those in Hong Kong or China.

With AT&T reaching agreement without assuming T-Mobile USA’s debt, the takeover appears cheaper on other metrics.

The purchase price represented a multiple of 7.1 times 2010 T-Mobile USA’s adjusted earnings before interest, taxes, depreciation and amortization, Deutsche Telekom said. That’s lower than the median Ebitda multiple of 9.3 for global telecommunications takeovers of more than $1 billion in the past five years, data compiled by Bloomberg show.

Capital Expenses

AT&T isn’t taking on T-Mobile USA’s debt that totaled $15.9 billion at the end of 2010 and will issue about $14 billion of shares to Deutsche Telekom, subject to adjustment.

The U.S. carrier said it will borrow money to help finance the cash portion of the purchase. AT&T has an 18-month commitment for a $20 billion unsecured bridge loan from New York-based JPMorgan Chase & Co.

AT&T is currently rated B3H, the third-lowest investment- grade rating, according to Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, market value, profitability and other financial ratios. The carrier would maintain its rating even after increasing its long-term borrowings by $25 billion, Bloomberg’s ratings show.

‘Track Record’

Cost savings and revenue gains may total $3 billion annually within three years, AT&T said. Based on expected so- called synergies of $40 billion, which are plausible, AT&T “believes it can acquire the asset for free,” according to a report from Craig Moffett, an analyst with Sanford C. Bernstein & Co. in New York.

AT&T agreed to buy BellSouth Corp. in 2006 for more than $80 billion in its largest acquisition, giving it full ownership of Cingular Wireless, the biggest U.S. mobile-phone operator at the time. At least $250 billion in deals in two decades has left the company’s market value at $167 billion, Bloomberg data show.

“The track record in general for deals of this size in any industry is not great,” said Walter Todd, who helps manage $950 million at Greenwood Capital Associates in Greenwood, South Carolina. “AT&T felt they needed to do this to try to compete with Verizon. They don’t have a choice.”

Overall, there have been 5,086 deals announced globally this year, totaling $526.4 billion, a 22 percent increase from the $430.3 billion in the same period in 2010, according to data compiled by Bloomberg.

To contact the reporters on this story: Sarah Rabil in New York at srabil@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.

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