Is the Sprint & T-Mobile Merger Too Risky?
With the announcement of the biggest telecom news of 2018, the merger agreement between T-Mobile US Inc. and Sprint Corp. (NYSE: S), we wanted to handicap the odds of US regulators approving the deal. The lack of an antitrust break-up fee in the agreement makes it clear that Sprint is eager to consummate this deal. Unlike previous merger attempts, this also indicates that Softbank, Sprint's majority owner is unlikely to walk away from the deal should regulators oppose it. There are three regulatory agencies that hold a potential veto in this matter -- the Federal Communications Commission (FCC) , U.S. Department of Justice and CFIUS. The standards each uses to evaluate a deal are different and so are the risks of a challenge.
Based on a detailed assessment using techniques like the FCC and DoJ, we believe the risks are high for either a challenge outright or for onerous conditions to be imposed on the merging entities.
Industrial logic for merger is strong: T-Mobile has made significant headway since 2013 and service revenues grew 47% through 2017 even as industry revenues shrunk 4%. Yet, at year-end 2017, it only had 17% revenue market share (RMS). During the same period, Sprint has struggled, with service revenues shrinking 22%. Over the years, T-Mobile and Sprint have made limited investments to augment network coverage and capacity. Each has invested approximately one third in wireless capex versus the leaders (Verizon Wireless and AT&T) and this under-investment over a sustained period will lead to inferior networks and ultimately weaker competition. With 5G looming, a merged T-Mobile-Sprint with its market-leading spectrum assets (Figure 1) and combined network investments could bring a competitive 5G offering to market.
CFIUS risk is low: T-Mobile is German controlled and so CFIUS is likely to review the merger. However, since both T-Mobile and Sprint are controlled by foreign entities and have been through such reviews and since Germany does not normally figure as a national security threat, this review is likely to be a formality.
FCC risk is low-medium: FCC's 2017 assessment of the mobile services market gives several pointers to how they will assess the impact of this merger. The FCC concluded that there was effective competition in the industry based on the following facts:
The FCC's number-one priority is to close the digital divide and encourage deployment of advanced telecom capabilities, and hence is likely to support a transaction that could foster innovation and increase investments.
DoJ risk is medium-high: The DoJ's approach to assessing competitive intensity, especially for horizontal mergers has historically employed a rigid standard (Figure 2) and leverages a widely used index of market concentration, the Herfindahl-Hirschmann Index (HHI).
The proposed merger will result in an HHI increase of over 350 points to approximately 3,250. Furthermore, the market concentration in key sub-segments is likely to increase even further (Figure 3).
This analysis indicates that the DoJ would very likely challenge the transaction.
What the regulators might miss: Across geographies, most countries have only three or four nationwide wireless operators. Among large, high-income countries across the Americas, Europe and Asia, the US market is among the least concentrated. Furthermore, there seems to be little if any correlation between market concentration and pricing for services (Figure 4).
Conclusion: The high fixed costs and scale-driven business model, increasingly concentrated vendor landscape and constantly evolving technology landscape that requires huge investments all drive a high level of market concentration for mobile services. The stakes are high for consumers, wireless value chain participants and the country's global competitive position as the industry begins the transition to 5G and we hope the regulators are thoughtful and forward-looking and enable the US to retain its wireless leadership.
— Cheenu Seshadri is Managing Partner at Three Horizon Advisors, a Chicago based advisory serving private equity and corporate clients within the TMT sector.