Quick Thoughts: T-Mobile and MetroPCS Make a Beautiful Couple

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–          Despite different technologies for 2G/3G, T-Mobile is a much better fit for MetroPCS than most analysts assume, offering far more synergies than would Sprint.

–          In particular, the two companies have complimentary spectrum, concentrated into two common bands with ample bandwidth to execute a smooth network transition and deploy 4G LTE

–          The combined entity will have much lower costs, better coverage, greater capacity for 4G, and handset interoperability with the market leaders, likely spurring share gains and margin expansion.

–          A resurgent T-Mobile offering prices a third or more below the market leaders with sharply improving network quality becomes a serious threat to the industry status quo.

 

The whisper that Deutsche Telekom was considering a merger of its T-Mobile USA subsidiary with the super regional carrier Metro PCS set the telecom blogosphere atwitter.  Most zeroed in on the incompatibility between the T-Mobile’s GSM/HSPA+ based 2G/3G network and MetroPCS’s CDMA infrastructure.  Handsets built for either of these two technical standards cannot be used on the other, leading many toward conjecture that Sprint, which also uses CDMA, would be a far more suitable partner for MetroPCS.  Moreover, many industry vets remember that, a decade ago, AT&T’s transition from its dead end TDMA to its current GSM/HSPA+ network cost it big time, both in capex and in customer frustration.  Poor service and spotty handset availability led many users to switch networks over to Verizon – exacerbated by the newly mandated number portability.  Arguably, AT&T is still trying to make up the ground it lost during that painful episode.

Of course, T-Mobile’s situation is completely different.  The plan is to migrate MetroPCS’ CDMA customers over to the T-Mobile network over the next three years as they upgrade their devices.  With the average life of a phone running less than two years, not that many CDMA customers are likely to be remaining when T-Mobile intends to turn off the MetroPCS network and it will be able to decide then whether or not to give them incentive to make the switch, making the overall transition costs very low.  Since both networks operate in the same PCS band, the vacated Metro PCS spectrum can be easily repurposed to support the legacy T-Mobile network, while the costs of running the second network essentially go away.

Meanwhile, both companies have blocks of AWS spectrum which can now be combined for a single, LTE network with 40-50MHz of paired spectrum in most metro markets.  While AWS is a much higher frequency than the 700MHz blocks that constitute the main piece of both Verizon and AT&T’s networks, and thus, requires smaller cell sizes, it is an advantage to have all of the spectrum within the same, widely supported, band and the total spectrum that the new T-Mobile will devote to LTE is not far behind the combined bandwidth across heterogenous frequency blocks that either Verizon or AT&T will deploy.

Indeed, Verizon and AT&T will each devote their own small piece of the same AWS spectrum band to LTE, a significant future boon for T-Mobile.  Because of AWS support, Verizon and AT&T customers will be able to take their 4G devices and use them on the T-Mobile network, with AT&T subscribers getting 2G/3G support in the PCS band as well.  This means it will be easier for T-Mobile to steal customers, particularly from AT&T, without having to bear the added expense of subsidizing a new smartphone.  “Bring your own phone, get a huge discount on service!” will be a very attractive sales pitch.

This sales pitch becomes even more attractive when you consider the quality of T-Mobile’s network, which should only improve with the addition of MetroPCS’ spectrum.  The most recent J.D. Power assessment of wireless network quality scored T-Mobile second overall, behind Verizon, but ahead of AT&T and well ahead of Sprint.  With data prices that are already 30-40% below the two leaders, the $5-7B in annual operating savings projected for the merger position the new T-Mobile to take an even more aggressive tack on prices and unlimited data usage, potentially spoiling the cash flow party for AT&T and Verizon in the process.  T-Mobile’s recent sale/lease back of its towers also bolsters the combined entity’s financial position to support the LTE build-out and possible further spectrum deals.  As T-Mobile doubles down on the US market, I think there is a very good likelihood for the deal to be a significant win/win for both sets of shareholders.

Of course, Sprint may come back with an offer for PCS of its own.  However, in the end, the synergies for Sprint are not as compelling as those for T-Mobile, largely because its spectrum holdings are far less compatible.  Sprint is using the idiosyncratic SMR frequencies that it gained in its Nextel acquisition to roll out LTE.  While these channels are in a relatively attractive band based on propagation characteristics, no other carrier in the world will be rolling out LTE there, meaning Sprint must convince semiconductor companies, equipment manufacturers and device makers to support the band just for a single customer.  Meanwhile, PCS’s AWS licenses are far less attractive on their own than they are combined with T-Mobile’s adjacent chunk.  Expect Deutsche Telekom to win this bidding war.

For our full research notes, please visit our published research site.

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