Wednesday, December 21, 2011

Deutsche Telekom: Still Nobody Home

U.S. markets are in an uproar about the failure of the ATT-DT deal for T-Mobile.  The management of Deutsche Telekom has, in our opinion, bungled its US investment right from the start.  An acquisition of Sprint by one of the U.S. wireless behemoths has already been deemed anti-competitive, as has now the acquisition of T-Mobile.  If maintaining some semblance of competition is important then some sort of partnership between T-Mobile and Sprint would seem to have the best potential for regulatory approval, as well as offering opportunity to add value. 

In all the talk, the fundamental problem is being overlooked: the U.S. wireless industry is killing itself slowly with its irrational pricing paradigms.  New customers are lured in with money-losing deals, while the most profitable customers are left to themselves, with the option of switching to get one of these deals.  Much of the movement to Sprint among people I know was driven by their irrationally priced "all in one" plans with unlimited data access.  Most of these people complained about the phone coverage but suffered it for the data plans.  Not surprisingly, Sprint gained lots of prepaid subscribers, but lost money, which is not a recipe for sustainable value. 

Surely, data plan users should be charged by the volume, time period, speed, and types of data that they are downloading over cellular networks.  Gas and electric utilities charge by the time period and time of year, since everyone accepts that it is the cost of building and sustaining the peak load capacity that has to be paid for at the margin. Cable is different because of the monopoly status of local carriers and the fact that their networks were built with generous subsidies.  Wireless is really just another utility.  Credit Suisse too notes the elephant in the room: "declining profitability of the whole U.S. (wireless) market." 

Sprint's disastrous commitment to buy 30.5 million i-Phones for $20 billion will keep the company in the red until 2014, according to the Wall Street Journal and other sources.  T-Mobile, by contrast, is projected by Credit Suisse to generate $5 billion in EBITDA or better in 2011, which would meet or exceed early 2011 guidance. Credit Suisse, which has recently reinstated coverage of DT, projects 2012 EBITDA of about $5 billion for T-Mobile, despite negative industry fundamentals and economic weakness.  This is pretty good performance in the face of strategic and operational mismanagement from the parent company.  An acquisition of Sprint would not make financial sense nor would it pass regulatory muster. 

Performance of the DT parent is another story altogether.  DT sports a 7.9% dividend yield today, and the German government's large stake in DT precludes management from pursuing any strategies that might add shareholder value but that would require reducing the dividend.  According to Credit Suisse, the ROIC for DT will be in the 5% range for 2012 and 2103.  The stock is rated by Credit Suisse as "Underperform."  All of this complicates the future of T-Mobile and puts its valuable franchise at risk.  U.S. regulators should be working proactively to ensure that corporate inaction or irrationality does not inadvertently make the U.S. wireless industry anti-competitive. 

However, a partnership makes sense, with perhaps Sprint differentiated as the "Wal-Mart of Wireless" and T-Mobile as the preferred brand for price conscious, loyal postpaid customer who wants a global network.  Data hogs should be priced so they either pay their freight or go to Verizon where they will generally pay more for their plans anyway.  A partnership would only work, in my opinion, if (1) it went away from encouraging adverse selection and churn by only talking price; (2) stopped letting the data hogs crowd profitable users out of the trough, and (3) the partnership didn't cut costs to the point where the service culture of T-Mobile disappeared.  Good people are leaving T-Mobile in droves.  This would have to stopped and the company would have to find a way to become a "hipper" organization to work for as opposed to say, ATT. 

Credit Suisse opines that after the failure of the ATT-TMo deal, TMo is left with "more spectrum, less debt, and a bigger range of U.S. options." We have always believed this to be the case, as it certainly is now.

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