Oct. 3 (Bloomberg) -- Deutsche Telekom AG agreed to combine its T-Mobile USA unit with MetroPCS Communications Inc., doubling down on the U.S. wireless industry after a failed effort to sell the business to AT&T Inc. last year.
Germany’s largest phone company will own 74 percent of the new business in a deal that pays MetroPCS shareholders $1.5 billion in cash, the companies said today. The combined entity will keep the T-Mobile name and be run by John Legere, the former chief executive officer of Global Crossing Ltd. who took charge of T-Mobile USA last month.
The deal is the latest attempt by Deutsche Telekom CEO Rene Obermann to revive the fortunes of T-Mobile, the fourth-largest U.S. carrier, more than a decade after the German company entered the American market. The combined entity will have sales of $24.8 billion and 42.5 million subscribers -- still well behind Verizon Wireless, AT&T and Sprint Nextel Corp.
“The two companies, being smaller players, have struggled to compete,” said David Heger, an analyst at St. Louis-based Edward Jones & Co. “Being a larger player, you might be able to gain access to some of the more popular handsets. You might also see some network cost benefits.”
MetroPCS shareholders, though, were looking for more generous terms in the transaction, said Kevin Smithen, an analyst at Macquarie Securities USA Inc. in New York. They probably wanted 35 percent of the new company, rather than 26 percent, he said.
MetroPCS shares tumbled 9.8 percent to $12.24 today in New York after the details of the transaction were announced. The stock had jumped 18 percent yesterday when Bloomberg first reported that the companies were close to a deal. Deutsche Telekom rose less than 1 percent to 9.75 euros today.
It’s difficult to value a deal when one of the sides is privately held, said Craig Moffett, an analyst at Sanford C. Bernstein & Co. in New York. An optimistic view would value the MetroPCS shares at about $18 in the transaction, including the cash, he said. That would imply a market value of $6.5 billion.
Walt Piecyk, an analyst with BTIG LLC in New York, said the merger values MetroPCS at $15 to $16, assuming the companies are able to deliver on their promise of synergies.
T-Mobile had about 33 million customers at the end of June, roughly a third of what Verizon Wireless and AT&T have apiece. MetroPCS will add 9.3 million, pushing the total above 42 million. Sprint, meanwhile, had more than 56 million customers in its most recently reported quarter.
MetroPCS’s customers are prepaid users, meaning they don’t have contracts and typically don’t have to pass credit checks. While that segment of the market has grown in recent years, pay-as-you-go users are seen as less attractive than long-term subscribers.
“The prepaid business is a very difficult business,” said Christopher Larsen, an analyst at Piper Jaffray & Co. in New York. “We are not fans of that. Conversion of MetroPCS subscribers to postpaid would be very difficult.”
Still, by merging with a publicly traded company, T-Mobile can get the benefits of an initial public offering without the hassles, Obermann said on a conference call.
“The transaction increases our financial flexibility as the combined company will be publicly listed,” he said. “This is equivalent for T-Mobile USA to an accelerated IPO with synergies.”
If T-Mobile backs out of the deal, the company will owe MetroPCS $250 million, said Legere, T-Mobile’s CEO. The reverse breakup fee that MetroPCS would pay is set at $150 million.
T-Mobile USA, with its headquarters in Bellevue, Washington, has lost 2.76 million contract customers over the past two years. That’s more than 10 percent of its subscriber base. The company is the only major carrier without Apple Inc.’s iPhone and has fallen behind rivals in embracing the latest network technology.
Sprint abandoned plans earlier this year to buy MetroPCS after the board rejected the transaction, which may have cost as much as $8 billion including debt, two people familiar with the plan said in February.
In the past month, Goldman Sachs Group Inc.’s Jason Armstrong and other analysts raised the possibility of Sprint renewing its attempt to buy MetroPCS. When word of the T-Mobile deal first surfaced yesterday, Sprint shares dropped 5.4 percent, though they rebounded 6.1 percent today.
Leap Wireless International Inc., MetroPCS’s rival in the prepaid market, dropped 18 percent to $6.23 today on concern that it will have fewer opportunities to find its own buyer.
T-Mobile USA and Richardson, Texas-based MetroPCS expect the deal to generate $6 billion to $7 billion in cost savings. Deutsche Telekom’s supervisory board and MetroPCS’s board of directors have already approved the transaction. The merger, which is slated to close in the first half of 2013, is still subject to approval by MetroPCS shareholders and regulators.
One of the main challenges will be avoiding the troubles Sprint encountered when it bought Nextel Communications Inc., said Piecyk, the BTIG analyst.
After Sprint’s $36 billion takeover of Nextel in 2005, the company struggled to integrate Nextel’s network. Sprint wrote off most of the acquisition and now plans to shut down the Nextel network next year.
“The value of the deal to PCS shareholders will rely heavily on synergies, which could be a tough sell given the differing technologies,” Piecyk said. “Just look at the unrealized synergies in the debacle of Sprint’s acquisition of Nextel.”
Legere, T-Mobile’s CEO, expects a different outcome. T-Mobile won’t be trying to integrate MetroPCS’s network, which uses a technology called CDMA, with T-Mobile’s largely GSM system, he said. Instead, the company will be moving both sides to a format called long-term evolution, or LTE. The merger also gives T-Mobile more airwaves to build out its networks.
“MetroPCS customers will see immediate benefits migrating to T-Mobile’s next generation,” he said on the conference call.
T-Mobile also is looking into getting the iPhone, he said today in an interview on CNBC. Apple’s device is the most popular smartphone sold by the three other major U.S. carriers.
Deutsche Telekom was advised on the deal by Morgan Stanley and Lazard Ltd., as well as law firms Wachtell, Lipton, Rosen & Katz; Cleary Gottlieb Steen & Hamilton LLP; K&L Gates; and Wiley Rein LLP.
MetroPCS worked with JPMorgan Chase & Co. and Credit Suisse Group AG, as well as Evercore Partners Inc. Its law firms were Gibson, Dunn & Crutcher LLP; Paul Hastings; Telecommunications Law Professionals; Akin Gump; and Fulbright & Jaworski.
AT&T failed to take over T-Mobile USA last year for $39 billion amid opposition by regulators. Since then, Deutsche Telekom has been working to set the business on a new path. In the past two weeks, it named Legere to head the division and agreed to sell the rights to operate some of T-Mobile’s cellular towers for $2.4 billion.
While Legere will become CEO of the new entity, MetroPCS Finance Chief Braxton Carter will become chief financial officer, the companies said. The new entity will operate T-Mobile and MetroPCS as separate customer units, led by Jim Alling, chief operating officer of T-Mobile, and Thomas Keys, president and chief operating officer of MetroPCS.
T-Mobile USA accounts for about 25 percent of Deutsche Telekom’s revenue. The parent company is struggling to return to growth in eastern European countries such as Greece, putting more pressure on its U.S. operations to perform.
“We are committed to creating a sustainable and financially viable national challenger in the U.S.,” Obermann said.