October?s Spectrum Sweepstakes

"Spectrum at Heart of T-Mobile/MetroPCS Deal" (Wall Street Journal, October 2, 2012)

"SoftBank Deal for Sprint Turns on Spectrum" (Wall Street Journal, October 22, 2012)

In October, two major wireless deals were announced: T-Mobile's merger with MetroPCS, and SoftBank's purchase of 74 percent of Sprint - both seemingly driven in part at least by companies' needs to acquire more spectrum.

In addition, Sprint made a move to increase its ownership and potential control over Clearwire, setting off new rounds of speculation. And, LightSquared, after a seemingly moribund effort to create a nationwide 4G network, made a last gasp move to obtain approval from the FCC.

Finally, China's two largest telecom manufacturers (Huawei and ZTE) may well become entangled in the approval process for at least one of this month's proposed transactions. Huawei and ZTE sell network equipment to Clearwire and SoftBank, and perhaps others in the U.S. market. In addition, they sell handsets to MetroPCS, Sprint, Verizon Wireless, and T-Mobile USA.

It seems pretty safe to say that, as we approach the end of the month, the wireless industry's wheel of fortune will probably spin a few more times before the current deals on the table play out.

Then there's the FCC itself. Beyond its strong advocacy of the need for four national wireless carriers and its seeming enthusiasm for "disruptive" wireless, it is preparing to auction off huge new (or repurposed) blocks of spectrum soon. How the agency's policy goals will intersect with the swirling currents of wireless transactions and congressional security concerns could be anyone's guess.

Stay tuned.

Here are a few observations about the two key October wireless developments.

T-Mobile/MetroPCS

Regarding the recently announced T-Mobile/MetroPCS transaction, most observers seem to agree with this initial observation from Citi Research's Michael Rollins ("Teleconomy 2012. Wireless Consolidation Takes a Surprising Path with DT merging T-Mobile USA into MetroPCS," Michael Rollins, Citi Research, October 3, 2012):

"The transaction . . .  is very helpful at improving [T-Mobile's] supply of spectrum on a 3-5 year view in some key cities.  However, the deal does not specifically address what we view as the larger need for T-Mobile USA to improve its marketing scale to better compete for postpaid subscriptions within the industry."

Indeed, MetroPCS is a leading prepaid vendor with a significantly different business model, one which includes lower margins and near-complete outsourcing of its customer care operations. While the companies have emphasized their plans for converging technologies, less has been made of the possibility that T-Mobile may adopt PCS' low-margin, low-service prepaid model for a growing part of its business.

Wouldn't the lesser path of resistance for the combined companies be to rely on T-Mobile to provide and market the more lucrative, but also more expensive, postpaid wireless market while keeping the MetroPCS brand (and operational paradigm) for both companies' combined prepaid markets? This approach would permit the new company to maintain both a high road full service operation while participating in the faster growth of the low road prepaid market?

But is the rapid growth of the prepaid segment is more than an artifact of the wretched economic times we've been experiencing? Or is it simply the emergence of this lower cost, lower service, lower margin business?

T-Mobile/PCS argues that they have an elegant and straightforward five year migration path from their disparate technologies today to LTE/HSPA+. But a former Sprint official warned that such a transition is "easier said than done." Paul Selah, former Nextel CFO and (current Sprint CEO) Dan Hesse's immediate predecessor at Sprint, lived through the nightmare that was the Sprint-Nextel combination. According to a Dow Jones report, "Mr. Saleh said Sprint and Nextel also were planning to migrate users of both their networks to a common third technology, just as T-Mobile and MetroPCS have said they would do by shifting customers to a next generation LTE network.  However, for Sprint, merging the networks proved trickier than expected . . .  [Mr. Selah suggested that] it may be difficult for the merged company to move all of its MetroPCS customers to the T-Mobile network . . ."

Even though the T-Mobile/PCS deal has been announced, submitted to regulators for approval, and will shortly be submitted to MetroPCS shareholders for ratification, in the current spectrum sweepstakes environment, it seems more than a remote possibility that PCS is still in play.

First, as detailed in a New York Times article the day after the deal was announced, PCS' board has a legal fiduciary obligation to entertain competing offers. This article keyed its speculation on the possibility that Sprint might attempt to make a topping offer - a possibility which may have been undermined by the subsequent SoftBank/Sprint transaction. Many other sources continue, though, to wonder about the possibility that Sprint and/or SoftBank could move to acquire PCS or a combined T-Mobile/PCS.  As the New York Times writer observed, even assuming the deal closes as structured, "don't expect Deutsche Telekom to hold on to the shares for long."  As DT CEO Rene Obermann observed during the announcement call, the deal is actually a "turbo IPO" which should permit the German parent to liquidate its interest in the new entity more easily.

Finally, and predictably, two shareholder suits have already been filed against the deal. According to one source, plaintiffs argue  PCS is "substantially undervalued in comparison to its current stock price and that the merger is unfairly favoring the executive team at the expense of the shareholders by offering generous payouts to executives while offering no such payouts to majority shareholders." Another source says the plaintiffs argue that PCS' board and executives "are cheating shareholders in their 'drastically undervalued' merger."

It will be interesting to see if this legal action evolves into more than just another nuisance suit.

SoftBank/Sprint

And what about the $20 billion SoftBank/Sprint deal? The one in which Japan's SoftBank pours $3 billion immediately into Sprint and $5 billion upon consummation of the transaction, with another $12 billion going to Sprint's shareholders?

Goldman Sach's two leading U.S. and Japan telecom analysts, Jason Armstrong and Ikuo Matsuhashi, speculate that Sprint may not use all of SoftBank's cash infusion for network investment. They wonder whether Sprint will pursue additional merger and acquisition (M&A) transactions, including purchasing an even larger stake in its partner Clearwire, or perhaps making a counter-bid for MetroPCS? They speculate that there might be a Sprint/Dish deal ahead.

There are other implications for the SoftBank deal beyond these questions, particularly the involvement of Sprint partner, Clearwire. SoftBank and Clearwire purchase network equipment from Chinese companies Huawei Technologies and ZTE Corporation. Recently, the House Intelligence Committee issued a report, the result of a 13-month investigation, in which they concluded: that "risks associated with Huawei's and ZTE's provision of equipment to U.S. critical infrastructure could undermine core U.S. national security interests." The House Intelligence Committee recommended that the Committee on Foreign Investment in the United States, which must approve the SoftBank/Sprint transaction, "must block acquisitions, takeovers, or mergers involving Huawei and ZTE given the threat to U.S. national security interests."

I would add that although Clearwire is the fifth largest U.S. wireless provider in the U.S., it has very few direct customers; most are Sprint's. Stifel Nicholaus' Christopher C. King writes that[2]  the Softbank/Sprint deal "could help create a more robust ecosystem for Clearwire's (next-generation 4G) TDD-LTE network, as SoftBank is currently deploying the same technology in Japan, along with China Mobile."

This may indeed be a significant driver behind SoftBank's investment in Sprint. Since both SoftBank and Clearwire buy equipment from Chinese companies, Huawei Technologies Co. and ZTE Corporation, this could raise hackles among some in Congress as well as the Committee on Foreign Investment in the U.S.. The concern could be that a SoftBank controlled Clearwire/Sprint would use equipment with the potential for increased Chinese intelligence gathering. As a Bloomberg BusinessWeek October 8, 2012 headline put it, "Huawei, ZTE Provide Opening for China Spying, Report Says".

Following Sprint's recent earnings announcement and call, another major telecom analyst, Morgan Stanley's Simon Flannery, complained that "We are not much closer to understanding SoftBank's US strategy at this point." Flannery believes that the deal will close, but that the various approvals "will take longer than hoped." He is also skeptical about the transferability of SoftBank's experiences to the U.S. market. Flannery acknowledges that "SoftBank's turnaround of Vodafone Japan has been impressive, and there are undoubtedly lessons that Sprint can learn from the Japanese experience, as well as SoftBank's extensive internet expertise." Still, he continues, there are important differences that "may make it challenging for SoftBank to engineer a similar performance" in this country.  These include:

• the fact that the "US wireless market is mature with four national players (versus three in Japan) with postpaid subscriber growth running at around 1% per year,"
• that, unlike in Japan, the dominant companies already have the iPhone "(in Japan, NTT still does not offer the iPhone and KDDI only started offering it last year, well after SoftBank),"
• Verizon and AT&T are formidable competitors and "have a lead in LTE deployment, significant low band spectrum holdings and churn running at or near record low levels on family plans and business customers," and,
• that while number four wireless carrier T-Mobile has been losing around a half million postpaid subscribers per quarter, it "has committed to returning to growth in coming quarters."

Perhaps the lead skeptics about the SoftBank/Sprint deal are MarketWatch columnist Howard Gold and University of Virginia's Darden School of Business Dean Robert Bruner. In a recent post, Gold begins by noting that "some of the most spectacular deals" of the past decade "came crashing down to earth."  After a conversation with Bruner (author of a 2005 book entitled "Deals from Hell"), Gold reported that Bruner observed "when companies go too far afield, they're asking for trouble. . . Foreign bidders pay more than domestic ones, he said, helping investors in US target companies but not necessarily the acquirers."

Gold cites a Bloomberg BusinessWeek report that the ten largest overseas acquisitions by Japanese companies from 2000 to 2011 led to a "horrendous" $330 billion loss in market value for the acquiring company's shareholders. Moreover, Gold argues, "when it comes to M&A,  'bigger is, well, badder'." Citing a study of 12,000 acquisitions from 1980 through 2001, large firm shareholders lost some $226 billion when those acquisitions were announced "while small firm shareholders actually made $8 billion."

Gold writes that Bruner believes "private trumps public," meaning that good M&A returns usually involve smaller, privately owned firms.  Moreover, deals driven by CEO egos rarely succeed, Bruner observes.

Gold notes that both Sprint and SoftBank have already engineered their own "deals from hell."  For Sprint, that's obviously the disastrous Nextel acquisition, in which Sprint was soon forced to write off its investment, and from which it is still suffering.  In SoftBank's case, Gold reminds readers that SoftBank's Masayoshi Son dumped some $800 million into its acquisition of computer trade show company, Comdex, only to "essentially liquidate it a few years later."

Wrapping up his argument, Gold writes that Son "prides himself on being a risk taker, and there are plenty of warning signs this time around" and that in the context of the Sprint deal Son was quoted as crowing "I'm a man. It's part of my male ego to strive to be number one."

Gold then returns once again to Dean Brunner who observes that "the deals from hell have in common CEOs who display a lot of hubris or pride or overoptimism . . . This suggests someone who is forging ahead in the face of considerable risk."

Like Masayoshi Son, for instance?

Randy Barber

Guest blogger Randy Barber is the Director of the Center for Economic Organizing, and has served as an expert financial witness and telecom expert before numerous state and federal regulatory agencies. In this blog post, Mr. Barber analyzes the financial drivers and market implications of the two major wireless deals announced last month: T-Mobile/MetroPCS and Sprint/Softbank.

LightSquared tries to keep its 4G LTE dream alive (CNET, Oct. 2, 2012)

Chinese Telecom Executives Deny Government Control at U.S. Hearing (NYTimes, Sep. 14, 2012)

F.C.C. Backs Proposal to Realign Airwaves (NYTimes, Sep. 28, 2012)

Ex-Sprint official warns merging mobile techs isn't easy (WSJournal, Oct. 4, 2012)

Why MetroPCS Is Truly in Play (NYTimes, Oct. 4, 2012)

U.S. Panel Cites Risks in Chinese Equipment (NYTimes, Oct. 8, 2012)

M&A deals: the good, bad and ugly (MarketWatch, WSJ, Oct. 26, 2012)