Deutsche Telekom Risks U.S. Exit Without Boost: Real M&A

Unless Deutsche Telekom AG is prepared to abandon another attempt to exit the U.S. market, it has to sweeten the terms of its $33 billion deal to combine T-Mobile USA Inc. with MetroPCS Communications Inc.

Deutsche Telekom agreed in October to the merger, which gives MetroPCS investors $1.5 billion of cash and a 26 percent stake in a new entity that’s taking on $15 billion of debt from Deutsche Telekom. To win support from MetroPCS shareholders in an April 12 vote, New Street Research LLP says Deutsche Telekom may have to cut the debt component by $6 billion, while Nomura Holdings Inc. says MetroPCS owners want a bigger equity stake.

MetroPCS has rallied the most among Standard & Poor’s 500 Index phone stocks in the past three months amid optimism the offer will be improved, according to data compiled by Bloomberg. The shares closed at a five-month high on April 1 after two investor-advisory firms joined Paulson & Co., the biggest MetroPCS holder, in opposing the deal terms. While Deutsche Telekom could choose to walk away, that would represent another failed attempt to exit the business, following a 2011 agreement to sell T-Mobile to AT&T Inc. that regulators blocked.

“Deutsche Telekom has a problem: It’s probably going to be tough to get the votes it needs,” Keith Moore, an event-driven strategist at MKM Partners LLC, said in a telephone interview. “It’s highly unlikely that they do nothing and lose the opportunity, especially if you think back to how long they’ve been working to extricate themselves of T-Mobile.”

Latest Attempt

The deal is the latest attempt by Deutsche Telekom Chief Executive Officer Rene Obermann to revive T-Mobile, the fourth-largest U.S. carrier, more than a decade after the Bonn-based company entered the American market. Combined, T-Mobile and Richardson, Texas-based MetroPCS will still have a smaller market share than AT&T, Verizon Wireless and Sprint Nextel Corp., though the transaction would narrow the gap at a time when T-Mobile is trying to differentiate its service by offering cellular plans without contracts.

In an interview posted on Deutsche Telekom’s website in October, T-Mobile CEO John Legere said the MetroPCS deal is “not do-or-die,” adding that it would merely “accelerate a strategy that in and of itself will be successful.”

Andreas Leigers, a spokesman for Deutsche Telekom, said the current deal is beneficial to shareholders of both his company and MetroPCS. Representatives for MetroPCS and T-Mobile declined to comment.

NYSE Listing

By combining T-Mobile with MetroPCS, which is listed by the New York Stock Exchange, Deutsche Telekom will get the business trading publicly without an initial public offering. Not only that, it adds customers and airwaves to help rebuild the U.S. business.

T-Mobile lost 13 percent of its contract customers between 2009 and 2012 as it lagged behind peers in constructing faster networks and offering Apple Inc.’s iPhone. The decline continued in the first quarter, with the company losing 199,000 contract subscribers even as it gained lower-spending prepaid clients, according to a statement today. The second issue is being addressed on April 12, when the company begins selling the iPhone 5 for $99.99 plus two years of $20 monthly payments.

Today, MetroPCS shares rose 1.5 percent to $11.12, the highest closing level in more than five months. Deutsche Telekom added 2 percent to 8.52 euros, the second-largest advance in the DAX Index.

American Underdog

T-Mobile ranked No. 4 among carriers with about 9.2 percent of 2012 U.S. wireless service revenue, according to data compiled by Bloomberg on firms that publicly disclose information. Verizon Wireless was the leader at 34.1 percent, AT&T followed at 31.7 percent and Sprint was third with 15.6 percent, said Joshua Yatskowitz, a Bloomberg Industries analyst. Even with MetroPCS’s 2.4 percent market share, the combined company would have had only 11.6 percent of the region’s wireless business.

Deutsche Telekom has been the underdog in the U.S. since 2000, when it agreed to buy VoiceStream Wireless Corp. The company was later renamed T-Mobile USA. Since then, Deutsche Telekom has written down the value of T-Mobile, including a 7.4 billion euro ($9.4 billion) charge in November, after failing to close the gap with Verizon Wireless and AT&T.

The company almost found its exit in 2011, when AT&T agreed to buy T-Mobile USA. That deal was killed when AT&T withdrew its offer in the face of opposition from U.S. antitrust regulators.

Proxy Advisers

While Madison Dearborn Partners LLC, the second-biggest owner of MetroPCS, backed Deutsche Telekom’s October 2012 takeover agreement, opposition to the transaction has gained momentum.

Paulson & Co., MetroPCS’s top shareholder with a 9.9 percent stake, said in a Feb. 28 letter to the board that it will vote against the merger. John Paulson, the hedge fund’s billionaire founder, said the new company will have too much debt at too high an interest rate and that MetroPCS is worth more on its own. P. Schoenfeld Asset Management LP, which owns 2.5 percent and is leading the proxy fight, has asked shareholders to vote against the deal.

Even more pressure was placed on Deutsche Telekom to offer better terms last week when two of three investor-advisory firms that analyzed the deal came out against it.

Glass Lewis & Co., one of the three, said the current terms undervalue MetroPCS’s contribution to the merged entity. Institutional Shareholder Services Inc. recommended against the merger because of unfavorable terms and the potential for MetroPCS to thrive as an independent company.

Appeasing Shareholders

“The ISS report was the final straw,” Jonathan Chaplin, a New York-based analyst at New Street Research, said in a phone interview. It pushed the likelihood that management will get enough votes to complete the deal “from unlikely to highly unlikely territory,” he said.

The release of the Glass Lewis and ISS reports helped accelerate gains in MetroPCS shares, amid speculation Deutsche Telekom will be forced to improve the deal’s terms.

Deutsche Telekom could appease MetroPCS shareholders by rolling over just $9 billion of debt onto the new company instead of $15 billion, according to Chaplin.

“If they adjust the terms enough to win support, it will still be a good deal for Deutsche Telekom,” Chaplin said, citing future costs savings -- from items such as shutting down one of the networks run by T-Mobile and MetroPCS -- that have a net present value of $6.5 billion.

Lowering the debt would create more value for the combined company, said Roy Behren, who co-manages the $4.5 billion Merger Fund at Westchester Capital Management LLC in Valhalla, New York.

‘Main Concern’

“Our main concern is that the combined company would emerge with too much debt,” Behren said in a phone interview.

The Merger Fund along with a group of plaintiffs that own 12.5 million MetroPCS shares asked a federal court in Manhattan last week to delay the April 12 shareholder vote. The group said the deal represents “a windfall to Deutsche Telekom at the expense of MetroPCS shareholders,” according to the complaint.

The interest rate Deutsche Telekom will charge for the $15 billion intercompany loan may need to be lowered, and MetroPCS investors may also want a larger cash dividend or a bigger stake in the new company, said Michael McCormack, a New York-based analyst at Nomura.

“Most shareholders believe that the intercompany loan interest rate is fairly high,” he said in a phone interview. With those changes, “the deal can definitely get done.”

Higher Rate

The loan is composed of two sets of notes with maturities of six to 11 years, with rates of either 8.16 percent or 7.28 percent, according to the merger agreement. Similar-maturity junk bonds yielded 6.24 percent on average as of yesterday, according to Bank of America Merrill Lynch index data. MetroPCS, which has $5.5 billion of bonds outstanding, is ranked four levels below investment grade at B+ by Standard & Poor’s.

Heike Pauls, an analyst at Commerzbank AG in Frankfurt, said reducing the amount of debt and boosting the cash component of the deal are among options Deutsche Telekom has to appease MetroPCS shareholders.

“They should be able to make some concessions without upsetting their own shareholders too much,” she said.

Adjusting the terms won’t drastically increase the upside for shareholders, according to David Barden, an analyst at Bank of America Corp. in New York. MetroPCS would be valued at $7.65 a share, based on its owners getting a 26 percent equity stake in the new entity and Barden’s estimate that it will have $20 billion of net debt in 2014, he said in an April 2 report.

Value Range

The scenarios Barden examined valued MetroPCS at between about $7 and $13 a share, depending on how much the debt and equity stakes were adjusted. The shares closed at $10.96 yesterday.

During negotiations, MetroPCS had requested a 27.5 percent stake, before the companies settled on 26 percent, according to regulatory filings.

P. Schoenfeld Asset Management argued in a March 18 report that MetroPCS would be worth more without T-Mobile. In one so-called harvest scenario, the asset-management firm said MetroPCS would be valued at $13.27 a share based on the spectrum it could sell while continuing to operate by using another carrier’s network.

The investment firm hosted a conference call today to highlight its criticism of the deal, arguing that the debt component should be cut by $4 billion to make the transaction fair for MetroPCS shareholders. Other options to make the merger palatable include lowering the interest rate and boosting the equity stake for MetroPCS owners, PSAM said.

‘Uphill Battle’

“We believe collecting a majority vote against the T-Mobile merger remains an uphill battle and that any efforts at this point by dissident shareholders should be focused on extracting improved” merger terms, Louis Meyer, a special situations analyst with Oscar Gruss & Son Inc., wrote in a March 26 note to clients. He said MetroPCS shareholders may reluctantly vote in support of the deal even if Deutsche Telekom doesn’t sweeten the offer.

While small changes to improve the deal may not satisfy Paulson and PSAM, it could be enough to get the rest of the shareholders on board, said MKM’s Moore.

“I don’t think it’s going to take a lot to get the vote,” he said. “The most likely outcome is that they’re going to alter the terms, possibly by reducing the debt at the surviving company to basically make the MetroPCS stock they receive a bit more valuable.”

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