In the U.S. wireless world, the strong keep getting stronger. But is that good for consumers?
That will be a key question as Verizon Wireless seeks government approval for its $28.1 billion acquisition of Alltel from private equity investors, announced on June 5. With the addition of Alltel's 13 million customers, Verizon Wireless would jump past AT&T (T) as the nation's biggest cellular provider by a sizable margin. Together, Verizon and Alltel would have more than 80 million customers, compared with AT&T's tally of 71.4 million at the end of March.
The unexpected deal also underscores the shift of power in the mergers-and-acquisitions market, where corporations have regained prominence over the past year as the credit crisis choked off the debt financing that was so vital to the private equity boom. In fact, one of the last big deals of that boom was Alltel's takeover by TPG and GS Capital Partners, which are cashing out after less than a year for a paltry profit compared with many private equity paydays. While corporations such as Verizon have their own hard assets and cash flows to reassure lenders, private equity deals are financed by using the acquired business as collateral. Notably, Alltel's debt load had swollen to $22.2 billion from $2.7 billion as result of the private equity buyout, pushing the company's operations into the red. The banks that once freely financed such deals are under pressure to reduce their exposure to those loans.
Most analysts say the deal makes strategic sense for Verizon Wireless and that the company, owned jointly by Verizon Communications (VZ) and Vodafone (VOD), is getting a good asset at a fair price. What's more, Verizon Wireless executives promised to deliver at least $9 billion in cost savings over the first three years after the deal closes. That optimism was echoed in the stock market, where Verizon's and Vodafone's share prices each rose about 5% after the deal was announced.
Concern over Consolidation
But the deal is no slam dunk. Combining two companies of this size is always a challenge, as evidenced by the debacles seen in the merger of Sprint and Nextel. And by taking on Alltel's debt, Verizon Wireless will be more than doubling its debt load, to $38 billion. The increased interest expense could hamper the company's ability to invest aggressively in multibillion-dollar projects such as wireless network upgrades and replacing Verizon's copper phone lines with fiber-optic cables, says Ken Hyers, senior analyst at Technology Business Research.
Perhaps the biggest risk lies with government regulators. There is growing concern over consolidation in the U.S. wireless industry. Those fears were stoked earlier this year when Verizon and AT&T dominated a federal auction of especially valuable wireless spectrum, placing $16.3 billion of the nearly $20 billion in winning bids. Now, between this merger and recent word that T-Mobile's parent company may try to acquire Sprint Nextel (S), some consumer advocates are concerned that declining competition may bring higher prices and worse service. This could be especially true in Alltel's largely rural markets, which already have fewer wireless providers than major cities.
"This industry, which spends a lot of time convincing us how competitive they are, seems to be getting a lot less competitive," says Chris Murray, senior counsel with Consumers Union. And Rep. Edward Markey (D-Mass.), chairman of the House Subcommittee on Telecommunications & the Internet, issued a statement saying the proposed merger "merits the utmost scrutiny by antitrust officials and telecommunications policymakers to ensure that competition and consumers are fully protected."
Although most analysts think Verizon has a strong chance of getting the green light with little to no pain from the Bush Administration, those odds could decline sharply if the deal doesn't close before yearend. If the Democrats take the White House, the Federal Communications Commission could force Verizon to sell more of Alltel's assets and open its cellular network to connect with any device or application. If there are too many conditions, "it could put the deal in jeopardy," says Todd Rosenbluth, analyst with Standard & Poor's, which, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).
Cost Savings Touted
On a conference call after the deal was announced, Verizon executives expressed confidence that the company could overcome all the hurdles and that the merger would improve the company's earnings in its first year. "We've had some experience with the Justice Dept. to understand what their tests are," said Ivan Seidenberg, Verizon Communications chairman and CEO. Seidenberg stressed that integration risks would be reduced because the two companies use the same wireless technology. And while he declined to estimate the extent of the divestitures that regulators might require, Seidenberg said the companies overlap by only 15% in network coverage area.
In an interview with BusinessWeek, Chief Financial Officer Doreen Toben downplayed the idea that Verizon was taking on too much debt. "We have very low leverage," said Toben. "From a shareholder perspective, I have been besieged that our leverage is too low. We can lever up." S&P's Rosenbluth agrees: "We think they have the ability to take on this debt."
What's more, Toben said she was not worried about the company's promise to deliver $9 billion in cost savings as a result of the merger. "We think this is a conservative number," she said. About a fifth of the savings will come from a reduction in the roaming fees that Verizon Wireless currently pays when its customers use their phones on Alltel's network. Another fifth will come from reduced network expenditures, and a similar amount from cutting the companies' combined advertising budgets. The rest of the $9 billion, said Toben, will be generated by layoffs, store closings, and consolidation of billing systems, customer care tools, and data centers.
Spectrum Buy May Affect Merger Outcome
When asked if the deal was good for consumers, Toben said the merger would create more "stability in the marketplace," adding that Verizon would be "entering markets as a potent competitor." A merger could also give Alltel customers access to a much larger national network, exposure to new services such as downloadable music, and access to speedier wireless Internet access sooner.
But while analysts have long said the merits of such a merger were obvious, now some say the massive amount of spectrum that Verizon picked up in the FCC auction could change the tenor of the debate. "The 700 MHz auction changes the atmosphere by radically increasing the spectrum advantage that Verizon [and AT&T] has over its closest competitors," wrote David Kaut, an analyst with Stifel Nicolaus (SF), a research firm based in Washington. The departure of FCC Commissioner Deborah Taylor Tate later this year, added Kaut, could create the possibility of a 2-2 deadlock as the merger comes up for a vote. "We believe those developments increase both the scope of possible divestitures—which could be good for companies such as Leap (LEAP), MetroPCS (PCS), and rural carriers seeking additional spectrum—and conditions [which might include 'open access' commitments and roaming conditions]," wrote Kaut.
Of course, many mergers have drawn limited scrutiny under the Bush Administration. But Verizon's aggressive market moves and the growing power of the Democrats may produce a shift. "Increased market power allows you to raise consumer prices and perhaps get lazy about consumer service," says Murray of Consumers Union. "We are going to ask for careful scrutiny of this merger."