(By Mani) Finally, the consolidation doors in the U.S. wireless space opened with T-Mobile USA and MetroPCS Communications Inc. (NYSE: PCS) agreeing to merge, creating a stronger rival to Sprint Nextel Corp. (NYSE: S).
Media reports indicate that Sprint had been considering its own acquisition of MetroPCS, or a merger with T-Mobile. Sprint has been actively courting both T-Mobile and MetroPCS, which makes this merger a bit of a surprise.
"We believe Sprint, rather than Deutsche Telekom, could derive greater value from acquiring MetroPCS given its common technology platform and ability to realize network and IT synergies," RBC Capital Markets analyst Jonathan Atkin said in a client note.
If Sprint doesn't try to woo MetroPCS by a competing bid, then Leap Wireless International Inc. (NASDAQ: LEAP) is the last available option as it would give Sprint additional subscribers and synergies, ultimately removing a competitor.
Should a T-Mobile/PCS combination be consummated, Sprint would benefit competitively due to the significant potential for operational distractions.
Moreover, T-Mobile too may try to acquire Leap as the current merger wouldn't give it much firepower to compete with stronger rivals such as AT&T Inc. (NYSE: T) and Verizon Communications (NYSE: VZ).
"We do expect a bid for LEAP by either T-Mobile or Sprint within the next year," Oppenheimer analyst Timothy Horan noted.
Though Leap may be the last carrier standing, it is not an immediate target for the national carriers, and management would prefer to pursue a turnaround before considering a sale anyhow.
As of June 30, Leap had were approximately 5.9 million customers, a 2.7 percent increase from from the second quarter of 2011. Sprint served more than 56 million customers at the end of the second quarter of 2012.
Earlier in the day, MetroPCS and T-Mobile, an arm of Germany's Deutsche Telekom, agreed to combine in a reverse merger transaction.
Based on analyst consensus estimates for 2012, the combined company is expected to have approximately 42.5 million subscribers, $24.8 billion of revenue, $6.3 billion of adjusted EBITDA, $4.2 billion of capital expenditures and $2.1 billion of free cash flow in 2012.
The deal makes sense as both companies are losing subscribers at a relatively fast clip given fewer gross adds and high churn. MetroPCS is ramping its sales of more expensive 4G smartphones while T-Mobile does not sell the iPhone. The merger will add approximately 9.3 million prepaid customers to T-Mobile's base of 33.2 million total subscribers.
Moreover, the merger should help relieve pricing pressure, as T-Mobile and MetroPCS both announced significant price cuts in late August, and removes a competitor for both companies. As they say, less competition is always a positive.
"We also believe there would be substantial operating dis-synergies from revenue leakage as MetroPCS subscribers are moved to the T-Mobile network. In sum, we believe the dis-synergies from revenue leakage will offset much of the cost benefits," Oppenheimer analyst Timothy Horan said in a client note.
The combined company, which will retain the T-Mobile name, will be in a better position from a spectrum standpoint. MetroPCS has population weighted spectrum holdings of about 20Mhz in the 100 million POPs it covers (T-Mobile is at 60MHz), and both are in the PCS and AWS bands.
While MetroPCS's network does not immediately align with T-Mobile's (T-Mobile uses HSPA+ network technology, whereas MetroPCS has almost entirely upgraded to LTE-), this will soon change. T-Mobile is spending $4 billion to upgrade to LTE and is projected to launch LTE sometime in 2013.
"We expect T-Mobile to realize significant synergies in 2014, when the company will be able to form larger AWS swaths to use for LTE, thus relieving some spectrum constraints,"
The transaction is structured as a recapitalization in which MetroPCS will declare a 1-for-2 reverse stock split, make a cash payment of $1.5 billion to its shareholders and acquire all of T-Mobile's capital stock by issuing to Deutsche Telekom 74 percent of MetroPCS' common stock on a pro forma basis.
Deutsche Telekom has also agreed to roll its existing inter-company debt into new $15 billion senior unsecured notes of the combined company, provide the combined company with a $500 million unsecured revolving credit facility and provide a $5.5 billion backstop commitment for certain MetroPCS third-party financing transactions.
The combined entity is expected to have about $6 billion to $7 billion (net present value) of cost synergies and additional upside from revenue synergies and five-year compounded annual revenue growth rates in the range of 3 percent to 5 percent. The companies target an EBITDA margin in the range of 34 to 36 percent at the end of the five-year period and achievable projected cost synergy realization with an annual run-rate of $1.2 billion to $1.5 billion.
However, a T-Mobile/MetroPCS a combination would find difficult to achieve operating synergies, given the technology mismatch between the two platforms and the likely need to maintain separate networks, billing, and other IT and customer support systems until the migration of the PCS customer base onto the larger T-Mobile platform.
"Therefore, we assume the PCS's appeal to DT lies solely in its spectrum position (3.1B Mhz-POPs, mostly in top-20 markets)," Atkin said.