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More Telecom Deals Hardly a Sure Thing

Robert Holmes

Verizon's (VZ Quote) $28 billion acquisition of Alltel may not spur the massive industry consolidation some investors are anticipating.

Instead of a radical reshaping of the U.S. telecom landscape, competitive dynamics and pricing will largely remain intact, analysts say.

Verizon will leapfrog AT&T (T Quote) to become the largest U.S. wireless carrier, with more than 80 million subscribers, but that doesn't necessarily mean the urge to merge will sweep the sector.

AT&T has its own challenges that would keep it from trying to one-up Verizon right away. As if relinquishing the top wireless spot wasn't enough of a stomach punch, AT&T is still trying to expand its broadband and U-verse video services amid intense competition from cable operators, such as Comcast (CMCSA Quote), offering triple-play packages of voice, video and Internet. This struggle is being played out against a backdrop of a swell in access line losses as customers abandon traditional landlines.

Smaller rivals Sprint Nextel (S Quote) and Deutsche Telekom's (DT Quote) T-Mobile unit, with 53 million and 29 million subscribers, respectively, have been left to fend for themselves in a fully saturated market that is showing signs of markedly slower growth.

"When you talk about consolidation, people usually refer to those at the top end of the food chain," says Sanford Bernstein analyst Craig Moffett. "There is not an easy deal to pull off, both from a technology perspective and regulatory perspective. It's hard to see the sense in it."

As acquisitions become the only quick fix to bump subscriber counts higher, it seems counterintuitive that the market would actually see fewer telecom tie-ups. Stifel Nicolaus analyst Christopher King notes, though, that the Verizon-Alltel transaction may not "necessarily be a harbinger for future near-term telecom consolidation," considering how challenging it is to tap the capital markets these days. Additionally, King views Alltel as a unique asset with motivated sellers and a likely single potential buyer in Verizon.

"For Verizon, this deal was about buying a regional carrier," adds Steve Clement, analyst with Pacific Crest Securities. "It's complimentary technology, so it was a nice fit for Verizon. You're talking about adding 13 million onto a base of 67 million. I don't really think this will have much bearing on AT&T's decisions. With AT&T and Sprint, there'd be many more complex regulatory hurdles."

Michael Rollins, analyst with Citigroup, agrees that the Verizon-Alltel deal will make it harder for telecom names that look to merge in the future. "The transaction will increase the hurdles for future M&A for overlapping coverage footprints within the industry as industry concentration would increase," he says. "The disclosed footprint overlap between Alltel and Verizon is significant."

In addition to the regulatory factors, the technology each carrier uses for their respective networks prevents clean and pain-free merger deals. One month ago, Deutsche Telekom was rumored to be considering a bid for Sprint. Those whispers came a few short months after Sprint's board spurned a buyout offer from South Korea's SK Telecom (SKM Quote) and a $5 billion investment from private-equity firm Providence Equity.

A hypothetical T-Mobile-Sprint merger would require joining different network technologies. If there is one thing Sprint knows, it would be the headaches involved with combining two incompatible networks. Its $35 billion acquisition of Nextel's iDEN network in 2005 never lived up to the massive hype. Instead, Sprint has been hemorrhaging iDEN subscribers as the migration of Nextel users over to the Sprint PCS network has hit multiple snags.

Perhaps it seems odd, then, to hear Sprint's name come up in various takeover rumors, but the carrier has lately taken giant steps to make itself a more attractive acquisition target. Last month, Sprint and Clearwire (CLWR Quote) finally reached a deal to combine their WiMax wireless broadband businesses into a new communications company.

Around that same time, separate reports surfaced that Sprint was contemplating the spin-off or sale of its Nextel unit. Shedding Nextel would undoubtedly be the admission of a gigantic failure, but it would also rid Sprint of the iDEN technology, which some view as a favorable move in the eyes of potential suitors.

Still, Pacific Crest's Clement says that even if Sprint were to shed its iDEN assets, which would be a difficult maneuver, it would remain unlikely anyone would bid for the struggling carrier. "That would still be a messy transaction, assuming someone was still interested in the iDEN assets," he says. "T-Mobile could unify Sprint under [long-term evolution, or LTE,] technology. But this would be a tough deal to pull off."

Bernstein's Moffett adds that there are fewer subscribers left at Sprint, and that the subscriber number is spread out over different networks.

"It makes it increasingly difficult to do financially," he says. "It's not going to be easy to find a buyer." Moffett also notes that financing banks will also scrutinize any request for backing after the leveraged buyout for Alltel in 2007 yielded the lenders little benefit.

"The other lesson of the Alltel deal is that the banks involved simply weren't able to move the debt associated with that deal," he says. "It gets harder from here."

So where does that leave biggest wireless telecom names? As the market is increasingly flirting with saturation, telecom names might actually have to start focus on running their businesses successfully before searching for a dance partner.

"For all the talk the future of wireless data growth in this industry, it is still dominated by good old fashioned subscriber numbers," Moffett says. "One has to assume that growth is going to be harder to come by."

Clement has a more succinct view of the future of telecom consolidation. "I just don't see any of the M&A deals happening," he says.