By Kenneth M. Leon, CPA
In less than 12 months, we have seen significant changes in the U.S. wireless landscape. Nationwide carriers are getting larger, and smaller wireless carriers are fighting to remain competitive. Indeed, mergers and acquisitions have been occurring at a swift pace.
First came the acquisition of AT&T Wireless by Cingular Wireless for $41 billion in cash, plus net debt assumed. It will take time to realize the benefits of that deal. We continue to believe Cingular, a joint venture between SBC Communications (SBC : S&P investment ranking 2 STARS, sell; recent price, $25) and BellSouth (BLS : 1 STARS, strong sell; $27), paid a significant premium to fair value for AT&T Wireless in order to gain market-share leadership and the benefits from economies of scale.
Subsequent to the closing of the transaction last October, Cingular announced the booking of multibillion-dollar reserves to cover a lengthy transition period. In our view, it will take most of 2005 for Cingular to integrate and streamline network operations, to fine-tune retail outlets, and to sort out all of its direct sales and indirect distribution channels.
SUPERIOR GROWTH PROFILE.
Another milestone in early 2004 was the recombination of Sprint PCS with Sprint FON Group. On its own, Sprint PCS shares had one of the largest market capitalizations in the U.S wireless equity market. At the time, Sprint PCS and AT&T Wireless represented more than 50% of the market cap for the U.S. wireless services subindustry. In our view, the scarcity of wireless service pure-plays heightened the enterprise value for those remaining in one of the fastest-growing segments in the telecommunications industry.
Little did we know, but Sprint (FON : 3 STARS, hold; $24) embarked on another major milestone with the proposed merger with Nextel Communications (NXTL : 4 STARS, buy; $29). On Dec. 15, the two companies announced a proposed merger of equals, subject to necessary approvals. We concur with management that the new company would have a superior growth profile, an attractive asset mix, industry-leading margins, and a significant customer base that would rank right below Verizon Wireless -- a joint venture of Verizon Communications (VZ : 5 STARS, strong buy; $37) and Vodafone (VOD : 3 STARS; $26) -- and Cingular.
One of the interesting dynamics of "Sprint Nextel," in our view at S&P, would be its operating profile as a national wireless carrier and a global IP network provider. We see this proposed merger as a solid opportunity to bundle multiple services for the business and government sectors. Already, Sprint and Nextel have operating agreements with other wireless carriers to provide wireless roaming capability in the Americas.
The planned merger isn't expected to close until sometime in the second half of 2005. In our opinion, significant one-time charges may be booked by Sprint for transition costs once the merger is consummated. Like Cingular, we would expect Sprint to begin to rationalize and streamline the combined sales and marketing activities. We also expect the elimination of duplicate back-office activities related to administration and customer service support services.
One of the challenges for Sprint, in our view, will be running two separate networks with two different brands for Sprint and Nextel, should management decide that is the right course. Unlike Cingular and AT&T Wireless, which operate on GSM-based networks, Sprint uses CDMA technology, while Nextel uses the iDEN-based architecture. Therefore, management isn't planning on moving Nextel's subscribers to Sprint's CDMA 3G network platform until 2007.
In our view, this means the merits of the planned merger may be less focused on cost-cutting and more driven by higher revenue generation and market-share opportunity. We expect Sprint Nextel to have the highest average revenue per user in the wireless industry and to be positioned to lead the industry in sustainable revenue growth.
NEW NO. 5?
On Jan. 10, 2005, ALLTEL (AT : 3 STARS; $55) reached an agreement to purchase Western Wireless (WWCA : 3 STARS; $38) in a stock-and-cash transaction valued at approximately $6 billion. ALLTEL would gain about 1.4 million domestic wireless customers in 19 Western and Midwest states that are contiguous to existing properties, giving it 10 million domestic wireless customers in 33 states. It would also add 1.6 million international customers in 6 countries.
The proposed transaction, expected to close by mid-year 2005 subject to all approvals, is expected to be accretive to earnings in 2006. The agreement requires approval from Western Wireless shareholders and regulatory authorities. The stock portion of the merger terms is expected to be tax-free to Western Wireless shareholders.
Therefore, ALLTEL may end up the fifth-largest wireless carrier in the U.S., covering 25% of the population and 56% of the U.S. land mass. The company's revenue mix would increase to 70% wireless, and it would diversify its presence into international markets such as Austria and Ireland. Operating on CDMA technology, ALLTEL may still be viewed as an attractive potential takeover target in the future, in our opinion. Prior to ALLTEL's announcement, there was speculation in the media that Verizon Wireless was considering a bid for ALLTEL.
We believe T-Mobile USA, a subsidiary of Deutsche Telekom (DT : 3 STARS; $21), may lag behind its major competitors -- Verizon Wireless, Cingular Wireless, and Sprint Nextel. T-Mobile finished the September, 2004, quarter with 16.3 million subscribers, which is way below the pro forma total net subscribers of the other three carriers, which are near or above 40 million.
We believe it may be hard for T-Mobile to gain significant market share going forward, and its strategy has been targeted to the youth and consumer wireless markets. Nonetheless, we think T-Mobile does have one competitive advantage with its seamless global brand, reach, and roaming with GSM-based network technology.
What's the impact on consumers from less competition? The number of wireless competitors will likely narrow in the year ahead. Based on the 2003 FCC Report on Wireless Competitiveness, more than 71% of the U.S. total population had a choice of six or more wireless service providers. If we assume that there were six nationwide carriers at the time of the study, today this group has narrowed to only four nationwide carriers, which represented close to 95% of total net new U.S. subscribers in the September, 2004, quarter.
With this in mind, we believe the rest of the wireless industry pales in comparison to how concentrated the U.S. wireless services market has become.
Our investment outlook for the wireless telecommunications subindustry is neutral, with increased pricing pressure expected over the next 12 months. We see signs of increased competition from wireless carriers that are boosting handset subsidies and monthly service plan minutes of use to renew existing customer contracts or acquire new subscribers.
To date, we see no evidence of aggressive pricing related to monthly service rates, but believe it remains a key indicator to gauge the industry's changing outlook with consolidation. We believe Cingular, T-Mobile USA, and Verizon Wireless will be aggressive in the market to gain share away from Sprint and Nextel during their transition period.
Nonetheless, we note that wireless providers with lower exposure to the consumer market may be less vulnerable to price pressure. We see Nextel Communications and Nextel Partners (NXTP : 4 STARS; $20) as well positioned with an attractive revenue mix coming from the enterprise and government segments. These markets have higher customer retention, lower churn, and higher subscriber returns than the consumer market.
Note: Kenneth Leon has no stock ownership or financial interest in any of the companies in his coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com
Analyst Leon covers wireless telecom services stocks for Standard & Poor's Equity Research Services
Edited by Steve Rosenbush