5G and Beyond

T-Mobile, Sprint Combo Could Threaten German Digitization

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.

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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.)

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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