Deutsche Telekom Buys Time for T-Mobile From Breakup Package

Deutsche Telekom AG, whose proposed $39 billion sale of T-Mobile USA to AT&T Inc. (T) collapsed yesterday, has about a year before it needs to start the search for another partner amid rising costs for improving its network.

A breakup package that includes the payment of $3 billion in cash to Deutsche Telekom will only cover T-Mobile’s expenses for 12 to 24 months, said Wolfgang Specht, an analyst at WestLB AG in Dusseldorf. If T-Mobile doesn’t find a new partner after that time, it risks failing to generate enough operating cash flow to cover capital spending, he said.

“Stabilization is the first step and then it’s about finding a new partner in the medium term,” said Specht, who has an “add” recommendation on Deutsche Telekom shares. “In the long run a standalone strategy seems impossible. Everything from here on is only a second-best solution.”

AT&T and Deutsche Telekom agreed to abandon this year’s biggest transaction, which would have created the largest U.S. mobile-phone operator and dethroned market leader Verizon Wireless. Bonn-based Deutsche Telekom cited unwillingness by the U.S. Justice Department and the Federal Communications Commission to change their “non-supportive stance” even after the companies proposed changes to the size and structure of the March 20 transaction. The Justice Department sued in August to block the deal.

Roaming Agreement

Deutsche Telekom fell 0.6 percent to 8.84 euros at the close of trading in Frankfurt, valuing Europe’s largest phone company at 38.2 billion euros ($50 billion). The stock has dropped 8.5 percent this year. Dallas-based AT&T climbed 1.3 percent to close at $29.12 in New York.

T-Mobile’s value has fallen to about $19 billion, Berenberg Bank analyst Paul Marsch wrote in a Dec. 12 note, citing a survey the bank held with about 40 investors “a few weeks back.”

To generate cash, Deutsche Telekom may reconsider plans to sell its tower network in the U.S., Chief Financial Officer Timotheus Hoettges said on a conference call today. A sale of those assets, which was considered until the AT&T agreement, may bring as much as $3 billion, said Jonathan Atkin, an analyst at RBC Capital Markets.

In addition to the $3 billion in cash, T-Mobile will receive a package of wireless frequencies from AT&T in 128 market areas, including Los Angeles, Dallas, Houston, Washington and San Francisco. The separation agreement also includes a roaming deal lasting at least seven years, which Deutsche Telekom said will improve T-Mobile’s coverage to 280 million potential customers from 230 million.

Investment Needs

The entire package is valued at about $6 billion, Chief Executive Officer Rene Obermann said on the call, citing estimates by experts.

“Our first and biggest challenge is to improve the spectrum situation,” Obermann said in an interview on Bloomberg Television. “The current spectrum is not good enough for a clear path to LTE and we’ll have to find alternative solutions.”

T-Mobile USA spent about $3 billion annually on capital expenditures in recent years, including network upgrades, the CEO said. Upgrading to the faster long-term evolution technology being rolled out by its competitors, including new spectrum, may cost $8 billion to $9 billion and such a process may take three years, RBC’s Atkin said.

T-Mobile USA lost 849,000 contract customers in the first nine months of the year. Its operating income before depreciation and amortization was $3.91 billion in that period, compared with $4.14 billion a year earlier.

European Woes

T-Mobile USA CEO Philipp Humm has done an “excellent” job during recent months, Obermann said, adding that he considers the manager “well-placed” to continue running the business.

Obermann had planned to part with T-Mobile USA to focus on restoring growth in Europe amid a debt crisis that has reduced demand for phone services. Before Deutsche Telekom agreed on the deal with AT&T, it had also held talks with Sprint Nextel Corp. (S), people with knowledge of the matter said in March. Sprint remains a potential suitor for T-Mobile in the future, said RBC’s Atkin.

“They’ll need to make the asset as competitive as they can, not only to bring in good results for the operating business, but also in order to fetch a better price at a future date,” he said.

Deutsche Telekom, which has vowed that its U.S. unit must finance itself, may also consider an initial public offering for the business or issue debt through the division, said Mark Chapman, an analyst at CreditSights in London.

Network Upgrades

Obermann declined to comment today on a potential partnership or a sale of T-Mobile USA to another company, adding that Deutsche Telekom will concentrate on improving T-Mobile’s operating performance. The spectrum from the breakup package won’t be enough to cover upgrades to LTE technology, Obermann said.

“In the longer term we have disadvantages with regards to scale and mobile frequencies,” he said. “That’s why in the coming months we’ll look closely into how we will be able to offer LTE despite the scarcity of spectrum.”

T-Mobile may reduce the costs of an LTE rollout by sharing next-generation wireless infrastructure with AT&T or Sprint, Atkin said. For additional frequencies, T-Mobile may look to Clearwire Corp. (CLWR) or Sprint for more spectrum, or wait for the next round of spectrum auctions in the U.S., which may come in as little as six months, he said.

Verizon Deal

T-Mobile missed a potential opportunity to purchase additional wireless frequencies this month after Verizon Wireless agreed to buy spectrum valued at $3.6 billion from cable companies Comcast Corp. (CMCSA), Time Warner Cable Inc. (TWC) and closely held Bright House Networks LLC. Phone companies need wireless frequencies to add capacity to meet increasing demand for high-speed mobile Internet devices.

“We think they will go back to the old fashioned sort of plan - run the business,” Sanford C. Bernstein analyst Robin Bienenstock wrote in a note today. “T-Mobile USA will compete for prepaid customers and hope that Sprint or someone else comes under enough strain they free up more spectrum.”

To contact the reporter on this story: Cornelius Rahn in Frankfurt at crahn2@bloomberg.net

To contact the editor responsible for this story: Kenneth Wong at kwong11@bloomberg.net

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