T-Mobile, Sprint Combo Could Threaten German Digitization

If a merger between T-Mobile and Sprint falls short of its targets, it could add to the pressure on Deutsche Telekom in Germany.

Iain Morris, International Editor

May 2, 2018

8 Min Read
T-Mobile, Sprint Combo Could Threaten German Digitization

US authorities might think blessing a merger between T-Mobile US and Sprint will help to keep their country ahead of China in the 5G race. The two operators, after all, have promised to spend heavily on a 5G network. But if a merger proves a major distraction for Deutsche Telekom, T-Mobile's German owner, could it also hold up digitization in Germany, which is similarly battling China for technological supremacy? (See T-Mobile to Buy Sprint for $26.5B to Create US 5G Powerhouse and Can the 'New' T-Mobile Make America's Networks Great Again?)

That appears a genuine risk if the merger falls short of specified financial targets and ends up consuming Deutsche Telekom's resources. The state-backed German incumbent, which would be the enlarged T-Mobile's biggest shareholder with a 42% stake, has been at pains to insist the tie-up will not endanger investments in Germany, where it is building higher-speed fixed and mobile networks. But its financial health would clearly suffer in the wake of a transaction. (See DT Will Start Commercial 5G Trials in 2018 and DT to Splurge €12.5B in 2018 Capex as It Preps for 5G.)

Figure 1: Odd Couple Timotheus Hottges, Deutsche Telekom's CEO, and John Legere, his counterpart at T-Mobile US, believe a merger between T-Mobile and Sprint will provide a stronger challenge to market leaders AT&T and Verizon. Timotheus Höttges, Deutsche Telekom's CEO, and John Legere, his counterpart at T-Mobile US, believe a merger between T-Mobile and Sprint will provide a stronger challenge to market leaders AT&T and Verizon.

This is mainly because Sprint Corp. (NYSE: S) comes with about $32 billion in net debt. As a result, Deutsche Telekom's overall net debt could rise to about 2.9 times its adjusted earnings (before interest, tax, depreciation and amortization). It will certainly exceed the "comfort zone" ratio of 2-2.5 until at least 2021, assuming a merger goes ahead in 2019.

Under plans announced earlier this year, Deutsche Telekom AG (NYSE: DT) plans to spend more than €5 billion ($6 billion) annually in its domestic market. It reaffirmed this commitment when announcing the Sprint deal this week. "Deutsche Telekom is sticking to its ambitious expansion plans for its fiber optic and 5G networks in Germany," said the operator in a detailed statement on the merger agreement.

But it has left itself with little room for maneuver. "It is clear that their ability to raise spending materially above this level will be constrained," Berenberg analyst Usman Ghazi tells Light Reading. Given labor and logistical bottlenecks in the German market, Ghazi has doubts this target was realistic in the first place. The Sprint deal could make it even harder to achieve.

Concern is already rife that Europe is in the digital slow lane compared with the US and China. Germany is a broadband laggard even by some western European standards. While many homes and businesses in France and Spain are now hooked up to super-quick all-fiber networks, Germans remain stuck with much slower connections using copper-based technologies like VDSL.

Change is coming. Under Deutsche Telekom's latest investment plans, "there will be a progressive shift out of VDSL into fiber," says Ghazi. But the transition is not happening fast enough, as far as some German politicians are concerned. With an economy that still relies heavily on manufacturing, Germany arguably has a greater need than other European countries for the low-latency connectivity that 5G and underlying fiber networks promise. Without these, and the applications they will support, Germany's Mittelstand companies could be left choking on the dust kicked up by their digitally powered Chinese rivals. (See Industrie 4.0: Rebooting Germany, Germany's Gigabit Lag and Germany's 5G Auction & the Gigabit Dream.)

Deutsche Telekom CEO Timotheus Höttges, who would become chairman of a merged T-Mobile US Inc. and Sprint, has been a regular critic of Europe's tough regulatory environment. Some observers blame this for Germany's shortcomings. But Deutsche Telekom's desire to be a "kingmaker" in the US, as Höttges puts it, should worry any German politician.

Next page: Grand designs

Grand designs
If they get the approval they seek, T-Mobile and Sprint have promised to invest $40 billion over three years in total capital expenditure. A big chunk will go toward the rollout of 5G networks. These assurances look designed to win over authorities concerned the deal would spell trouble for consumers and industry employees.

That's because they portend a big increase on current spending. T-Mobile is guiding for capital expenditure of between $4.9 billion and $5.3 billion in 2018. Sprint seems likely to spend around $3.5 billion in its current fiscal year, ending in March. Even at the upper end of the range, this would equal just $8.8 billion in total. The figure is about $4.5 billion less than operators would spend annually under their merger plans.

T-Mobile and Sprint have tried justifying these spending plans to investors through some very bullish forecasts. In the three or four years following the deal, they expect sales to increase at a compound annual growth rate (CAGR) of 2-4%. In the long term, they say, this CAGR will rise to 3-5%. The implication is that annual revenues will soar to about $95-100 billion from about $76 billion today.

Investors should view these predictions with skepticism. Sure, T-Mobile is still on a roll, in its current form. Its revenues were up 6.5% in the first three months of the year, to about $7.8 billion, compared with the year-earlier quarter, and they rose 8.3%, to $30.2 billion, in 2017. But the same cannot be said for Sprint. Yet to report any figures for 2018, it suffered a 2% dip in revenues in the last nine months of 2017, to $24.3 billion. The company view, it seems, is that Sprint will fly along in T-Mobile's slipstream post-merger. It could turn out to be deadweight.

Indeed, as a big company wrestling with the integration of two businesses, T-Mobile would struggle to maintain its current momentum. And the existing industry giants have found life much harder than T-Mobile. AT&T Inc. (NYSE: T)'s revenues were down 2% last year, to $160.5 billion. Verizon Communications Inc. (NYSE: VZ)'s stayed the same, at $126 billion.

Moreover, there is little remaining opportunity for growth in the US mobile market. T-Mobile and Sprint, no doubt, will point to 5G as a new sales opportunity. But consumer upgrades to next-generation technologies have not previously been accompanied by an increase in spending.

Operators' real hope is that 5G will unlock business in enterprise sectors, allowing them to sell connectivity and applications for connected cars, remote surgery and factory automation. This explains why it could prove so important in Germany. Yet some analysts are unconvinced operators will reap the benefits. Bengt Nordström, the CEO of the Northstream consulting group, thinks systems integrators like Accenture and Capgemini stand more chance of profiting in this "Internet of Things" market.

Want to know more about 5G? Check out our dedicated 5G content channel here on
Light Reading.

But if the sales targets look optimistic, the profitability goals are even more questionable. Today, Sprint and T-Mobile would report an EBITDA margin of about 40-42%. Three or four years after the merger, this will rise to 45-47%, they say. And it will hit 54-57% in the long term. This will happen, remarkably, even though Deutsche Telekom's plan "is for the larger company to employ more staff than the previous companies put together."

Balderdash, say unions. Communications Workers of America issued a statement in October, when a deal previously seemed likely, warning that a tie-up would destroy 20,000 jobs. In their present form, T-Mobile and Sprint would have 79,000 employees, giving the combined entity per-employee revenues of about $935,500. The figure would easily beat AT&T's of $632,000, and Verizon's of $811,000. But Deutsche Telekom wants to slash annual costs by $6 billion starting in 2024. It has talked specifically about realizing savings in network operations, sales and marketing, customer support and IT. That seems to contradict the statement about taking on additional staff. (See T-Mobile Talks Up Its Quad Play Opportunity & Network Savings by Buying Sprint and T-Mobile & Sprint: Marriage made in hell.)

Figure 2: Revenues Per Employee ($) Source: Companies. Source: Companies.

It may be that Deutsche Telekom plans a short-term boost to cope with integration challenges and build a 5G network. If so, this will provide some relief for an industry that has shed tens of thousands of jobs in the last couple of years. Either way, an EBITDA margin target of more than 54% in the long term looks ambitious, to say the least. (See Efficiency Drive by Major Telcos Has Claimed 74K Jobs Since 2015.)

Falling short of that target will put others at risk. T-Mobile and Sprint believe they can generate $10-11 billion in free cash flow three or four years after a merger, up from just $1-2 billion in 2019. In the long term, free cash flow will hit $16-18 billion, the companies reckon. They aim to use this pay off their loans. If all goes to plan, net debt will fall from about 2.9 times EBITDA in 2019 to 1.8 times EBITDA in three or four years. The long-term forecast is for a net-debt-to-EBITDA ratio of just 0.2-0.3.

Realizing these ambitions would silence any critic and make the case of T-Mobile and Sprint required reading for students of consolidation. It should also take pressure off Deutsche Telekom in Germany, where the rollout of 5G and supporting network infrastructure will gobble up funds in the next few years. If US authorities back this deal, their counterparts in Germany will pray the tie-up is a roaring success.

— Iain Morris, International Editor, Light Reading

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About the Author(s)

Iain Morris

International Editor, Light Reading

Iain Morris joined Light Reading as News Editor at the start of 2015 -- and we mean, right at the start. His friends and family were still singing Auld Lang Syne as Iain started sourcing New Year's Eve UK mobile network congestion statistics. Prior to boosting Light Reading's UK-based editorial team numbers (he is based in London, south of the river), Iain was a successful freelance writer and editor who had been covering the telecoms sector for the past 15 years. His work has appeared in publications including The Economist (classy!) and The Observer, besides a variety of trade and business journals. He was previously the lead telecoms analyst for the Economist Intelligence Unit, and before that worked as a features editor at Telecommunications magazine. Iain started out in telecoms as an editor at consulting and market-research company Analysys (now Analysys Mason).

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