Why regulators are likely to reject a Sprint/T-Mobile deal

When it comes to competition in the US mobile market, federal regulators see four as the magic number. This fact alone could sink Sprint's rumored takeover bid for T-Mobile.

The Wall Street Journal reported over the weekend that Sprint is preparing a $20 billion bid for T-Mobile in an acquisition that would reduce the total number of national wireless operators from four to three. But regulators in Washington, DC, have already signaled that they're likely to put the kibosh on such a tie-up.

Sprint's bid for T-Mobile could be announced early next year, according to the Journal. Citing sources close to Sprint, the newspaper said that SoftBank Chief Executive Masayoshi Son is driving the acquisition talks. Son led Softbank's acquisition of Sprint earlier this year. The Japanese telecom operator fought off a competing bid from satellite TV provider Dish Network to ultimately win 80 percent of Sprint.

For years there has been talk of Sprint and T-Mobile, the third and fourth largest nationwide wireless operators in the US, teaming up to take on Verizon Wireless and AT&T, the No. 1 and No. 2 nationwide mobile operators. And there was a time, when such a deal made sense and might have won support from regulators. Even combined, Sprint and T-Mobile would not match either Verizon or AT&T in terms of total number of customers. And a combined Sprint/T-Mobile would still not cover as much footprint nor have as deep and wide a spectrum position as either AT&T or Verizon.

But today just two years after AT&T withdrew its $39 billion bid for T-Mobile, due to strong disapproval from regulators, it seems highly unlikely that those same regulatory agencies would feel much different about a Sprint/T-Mobile tie-up.

"Despite being a more palatable merger than AT&T/T-Mobile on pure antitrust grounds, we believe a Sprint/T-Mobile tie-up probably would face the same fate -- a challenge by DOJ and the FCC," Paul Gallant, an equities analyst Guggenheim Securities, said in a research note Monday. "We believe regulators are very pleased with T-Mobile's resurgence and its aggressive, innovative moves and would not want to see it disappear via acquisition."

T-Mobile: The wireless maverick
One of the reasons that the Department of Justice and the Federal Communications Commission rejected the 2011 merger between AT&T and T-Mobile was because the regulators saw T-Mobile as a "maverick" in the industry that put pressure on its competitors with innovative service plans and pricing.

Indeed, T-Mobile has cemented that reputation this past year and has become the poster child for regulators hawkish about preserving competition. Since its failed merger with AT&T a couple of years ago, the company has doubled down on being the "maverick" of the industry launching its "Uncarrier" strategy, which in its first phase eliminated contracts. The company has continued to add other customer-friendly services, such as free international roaming and an early upgrade program. As a result the company has gone from losing hundreds of thousands of customers a quarter, to gaining customers.

"This time last year, I don't think anyone anticipated what was coming," Jim Alling, T-Mobile chief operating officer, said at an investor conference last week. "The biggest story is our customer turnaround. We went from losing 2 million customers last year to gaining customers again."

The strategy seems to be working. In the third quarter of this year, the company added a total of 1 million new customers to its network. About 648,000 of these customers were highly valuable, so-called postpaid customers, who tend to have stronger credit history and are willing to pay more each month. In total T-Mobile ended the quarter with 45 million customers.

T-Mobile has also made significant strides in building its 4G LTE wireless network using spectrum it acquired from AT&T as part of the consolation following the break-up of the proposed merger and using repurposed spectrum the company already owned. The company has also been putting to use spectrum it acquired from its acquisition of prepaid operator MetroPCS. As a result, T-Mobile now covers more than 203 million people in 254 markets throughout the US with 4G LTE service.

What's more, competitors have begun to answer T-Mobile with changes in their own policies. After T-Mobile announced an early upgrade plan, AT&T and Verizon Wireless followed with their own plans. And AT&T just a couple of weeks ago altered its pricing plan and now offers its wireless customers a discount on its monthly service if they bring their own phone to the AT&T network. This is the same idea behind T-Mobile's original "Uncarrier" service plans announced earlier in the year.

Regulators have taken notice of T-Mobile's success and the effect it has had on its competitors, and they have not been shy about patting themselves on the back when it comes to their role preserving T-Mobile as a competitor. In November, William Baer, the head of the antitrust division for the Department of Justice, told The New York Times in an article profiling T-Mobile's CEO John Legere that wireless consumers are benefiting from T-Mobile's aggressive new strategy.

"When you have feisty rivals whose survival depends on innovating and differentiating, they can gain market share and loosen the oligopoly," he told the newspaper. "That's exactly what T-Mobile has done."

The new chairman of the FCC, Tom Wheeler, has also signaled that his agency would likely not accept a merger among the top four nationwide wireless operators. During a question-and-answer session at Ohio State University earlier this month, Wheeler said in the context of the upcoming wireless spectrum auctions that he would like to keep four major wireless competitors in the market.

"The mobile business is today with four carriers a competitive business." he said. "And it's important it stay that way."

Analyst Paul Gallant said in his note that he feels these comments paint a clear picture of how regulators are likely to view a proposed merger between Sprint and T-Mobile.

"Some may have overlooked Mr. Wheeler's comment at the time because it was made in context of discussing the spectrum auction," he said. "But we view it as a clear signal that he (like Mr. Baer) would be disinclined to approve a Sprint/T-Mobile merger."

Comments from these top regulators aside, there are other more tangible reasons to believe that the FCC and DOJ would likely reject the deal. In the FCC's most recent Wireless Competition Report, the agency found that the wireless market is already "highly concentrated" by antitrust standards. So based on its own analysis and using a commonly accepted measure of market concentration called the Herfindahl-Hirschman Index, or HHI, a merger between Sprint and T-Mobile would only further concentrate the market.

In his research note, Gallant said that the HHI score itself may not sink the merger. But he said that it shifts the burden of the companies to explain why the government should allow further market concentration. It's likely that Sprint and T-Mobile could argue that together the companies could more effectively compete against AT&T and Verizon. Gallant concedes that regulators would likely give this argument serious consideration.

Is T-Mobile even interested in merging with Sprint?
But a bigger question to ask might be whether T-Mobile would even be willing to be gobbled up by Sprint. While the company's executives have publicly stated their willingness to examine future deals, the company is on a positive trajectory not only with the "Uncarrier" strategy, but also with its network build, which is nearly complete. The company is also preparing and positioning itself for the upcoming incentive wireless auction in 2015, which will put more low-frequency broadcast TV spectrum in the market.

It seems unlikely that T-Mobile, which suffered serious customer losses during the time its merger with AT&T was being considered, would be willing to risk its gains to team up with Sprint.

The Wall Street Journal noted in its story that Sprint has not made up its mind whether it will move forward with its bid. That makes sense given Sprint's acquisition track record and the fact the company is already struggling to keep customers satisfied.

Sprint, which is the third largest operator in the US in terms of subscribers, is the weakest among the national carriers at the moment. The company has been losing more customers this year than any of its three major competitors. The company also has a long history of missteps with acquisitions. In fact, it is today finally integrating wireless spectrum it bought in 2005 from Nextel. The shift to shut down Nextel's network, and the company's technological flip- flop from 4G WiMax to 4G LTE has resulted in massive customer losses.

Sprint's woes were exacerbated this year as the company also transitioned its network to a new infrastructure. It has been ripping out old gear and replacing it with a new more flexible network. But in the meantime, service has suffered and customers have not been happy. Throw on top of that the Softbank acquisition and a deal to bring Clearwire's assets back into Sprint, and it's been a very difficult time for Sprint.

Sprint's CEO Dan Hesse said at an investor conference last week that the company is going through some short-term pain that will eventually have long-term benefits. But it's not difficult to see why customers and consumer advocates would likely look at a merger between Sprint and T-Mobile as a loss for consumers.

Dish Network is the real wild card.
Still, this doesn't mean that the wireless industry is done consolidating. In fact, it's very likely that there will be more mergers in 2014. Most of these deals could be small, similar in size and scope to T-Mobile's deal with MetroPCS and AT&T's acquisition of another regional prepaid brand, Leap Wireless. The big question in terms of mergers and acquisitions in the wireless market is what will happen to satellite TV provider Dish Network.

The company already owns a big chunk of terrestrial wireless spectrum, which it could use to build a mobile network. It is also the only company bidding on a national license of the upcoming H block wireless spectrum. Dish tried to acquire Sprint and Clearwire earlier this year. And the company's founder has also been pursuing wireless assets from the bankrupt startup LightSquared. There is a chance that Dish may swoop in at some point to make a play in the market either by acquisition or by building its own network. One thing is clear, 2014 could be another interesting year of wheeling and dealing in wireless.