T-Mobile Drop Shows Regulatory Risk Trumps Deal: Real M&A

To see just how much power regulators wield over mergers, look no further than T-Mobile US Inc.’s shares yesterday.

The fourth-largest U.S. wireless carrier fell as much as 3.7 percent to $33 after Bloomberg News reported Sprint Corp. is nearing an agreement on a takeover price of almost $40 a share. While some investors may have been unhappy with the $31 billion valuation, concern that the deal will be blocked by regulators is the biggest reason for the discount, said MKM Partners LLC.

Takeovers that are scrutinized because of antitrust issues, such as US Airways Group Inc.’s merger with AMR Corp., often trade at a wide discount to the offer because of the difficulty in predicting regulators’ decisions. While skeptics such as MoffettNathanson LLC put the odds of approval for the T-Mobile deal as low as 10 percent, Albert Fried & Co. is more optimistic and said that even if it fails, Charlie Ergen’s Dish Network Corp. may bid for T-Mobile. Should the deal with Sprint actually close, investors who bought T-Mobile shares at yesterday’s closing price stand to make a profit of 19 percent.

“Putting all that together, shaking it up in the martini, I come out that it’s probably no better than 50/50,” Tom Burnett, director of research at Wall Street Access Corp., which specializes in mergers and event-driven research, said in a phone interview. For Sprint and T-Mobile, “that doesn’t mean they shouldn’t try it.”

Bob Toevs of Englewood, Colorado-based Dish said the company didn’t have a comment.

Deal Details

Sprint will offer about 50 percent stock and about 50 percent cash for T-Mobile in a deal that would value the company’s equity at about $31 billion, according to people familiar with the matter, who asked not to be identified because the process is private.

T-Mobile closed yesterday at $33.49, down 2.3 percent, after rising 65 percent in the prior 12 months on speculation of a takeover. The Bellevue, Washington-based carrier is majority owned by Deutsche Telekom AG.

Today, T-Mobile climbed 1.2 percent to $33.90 at 11:27 a.m. in New York.

Because a sale to Sprint has been so widely anticipated, investors may have used this week’s reports as an opportunity to “sell the news,” said Keith Moore, an event-driven strategist at MKM. The offer is also below recent estimates, Heike Pauls of Commerzbank AG wrote in a research note after the price was reported.

Spread Wideners

The deal’s timing adds an element of uncertainty for merger arbitrage traders, who seek to profit from the difference between the stock price of a target company when a deal is first announced and the price at which it will be acquired. The length of time it takes for a deal to close and the risk of that not happening determines the arbitrage spread, which narrows as the transaction nears completion.

For the T-Mobile deal, the agreement announcement is likely still several weeks away, according to people familiar with the matter, who have said it could come as soon as July. One person said it could possibly slip to August. And then there are the regulatory concerns.

“Even if a $40 deal is announced, it will trade at a real fat discount,” Moore of MKM said in a phone interview. That’s because the odds are “very low on getting approval.”

Regulators are likely to take issue with allowing a takeover of T-Mobile, the carrier that the Justice Department’s Bill Baer has said “spearheaded” increased competition in the industry, according to MoffettNathanson.

Keeping Promises

AT&T Inc. had to drop a planned purchase of T-Mobile in 2011 after failing to convince regulators it could remedy the market impact of absorbing the carrier. While Masayoshi Son, founder of Sprint majority-owner SoftBank Corp., has promised to cut prices if a deal is approved, that may not be enough to ensure competition, Craig Moffett, an analyst at MoffettNathanson, wrote in a report yesterday.

“Would the promise of one man to go against the grain be as secure a way to ensure long-term price competition in wireless as simply leaving more competitors in the market?” he wrote.

Sprint’s Son and Chief Executive Officer Dan Hesse got a “highly skeptical” response when they raised the possible deal with Federal Communications Commission Chairman Tom Wheeler on Feb. 3, people briefed on the meetings, who asked not to be named because the sessions were private, said at the time. The executives also met resistance in an earlier meeting at the Justice Department, the people said.

Beating Odds

Regulatory hurdles don’t necessarily mean deals won’t get done. Just look at Medco Health Solutions Inc., US Airways and Smithfield Foods Inc.

In March 2012, a month before pharmacy-benefit manager Express Scripts Holding Co. completed its purchase of Medco, the spread was so wide that traders had a chance to make a 90 percent annualized return, according to data compiled by Bloomberg. The concern was over whether the Federal Trade Commission would view the tie-up as hurting competition in the industry.

When the Justice Department sued to block the merger of American Airlines parent AMR and US Airways about a year ago, it sent a chill through the market, resulting in wider spreads for other deals that were awaiting regulatory clearance. A couple of months later, the antitrust challenge was dropped when the companies made concessions, and the deal closed shortly thereafter.

It took about four months for the Committee on Foreign Investment in the U.S., or CFIUS, to approve WH Group Ltd.’s purchase of Smithfield Foods, the biggest Chinese takeover of an American company. Traders who bought in July when the spread was widest may have made a 17 percent annualized return by the time it closed in September, data compiled by Bloomberg show.

Reward Potential

For T-Mobile investors who bought at yesterday’s $33.49 closing price, a successful sale to Sprint that closes in 12 months would imply a 19 percent annualized return, data compiled by Bloomberg show. If it closes sooner than that, the return would be higher.

The chances of regulatory approval may not be as slim as critics say, according to Sachin Shah, a special situations and merger arbitrage strategist at Albert Fried. Son and Hesse have argued a combined entity will be a super-maverick, a strong competitor that can help keep prices down, people familiar with the matter said in February.

The logjam of more than $130 billion of telecommunications and cable megamergers that would require regulatory review also increases the likelihood of the Sprint-T-Mobile approval, said Steve Gerbel, founder and president of Chicago Capital Management LP, a Chicago-based hedge fund focused on merger arbitrage.

Sandbox Time

“Their window of opportunity is right here, right now,” Gerbel said in a phone interview. “The regulators have to look at it this time around and say, ‘Wait a minute, everything has changed.’ They’ll be the weakest one in the sandbox, but they’ll be able to be in the sandbox, where if they don’t merge and they don’t get together, will they become irrelevant?”

Even if a deal with Sprint fails, T-Mobile investors will probably still get some sort of transaction, said Shah of Albert Fried. While Dish’s Ergen has said he doesn’t want to get in a bidding war over T-Mobile, the regulatory uncertainty and the stock-and-cash structure from Sprint give him an opportunity to make an offer, Shah said.

“If you’re him, why wouldn’t you take a shot at this?” he said. “As a T-Mobile shareholder, you’re going to be rewarded for that.”

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