ATT's T-Mobile Acquisition Is Risky, but Its Dividend Is Secure

ATT went all out last week and agreed to acquire the third largest wireless carrier in the US in T-Mobile after reaching an agreement with Deutsche Telecom to pay $39 billion ($25 billion of which will definitely be in cash). The acquisition is the biggest in the US telecom space since ATT’s acquisition of Bell South in 2006, and the largest pure play wireless acquisition since Vodafone’s acquisition of Mannesmann in Germany in 1998.

Opinions are divided as to whom the winners and losers in this transaction are. I would tend to agree with the prevailing view that the tower companies and major manufacturers of wireless equipment are going to be the losers in US market consolidation. The US consumer is also a loser because of the loss of competitive options and the loss of the only major company in the US wireless space that actually provided decent customer service.

The winners are certainly Verizon, Deutsche Telecom and Apple. Verizon can now expand and compete without anti-trust concerns and in all likelihood has one of its peskiest and most effective competitors removed. Deutsche Telecom is reducing its exposure to a mature marketplace in which it had little hope of growing its customer base, gaining a large equity position in ATT (which it will presumably begin to unwind after the 1 year lockup expires), and is freeing up capital in order to pay down its debt and expand elsewhere. Apple is probably a winner because the market for its products just grew by 36 million (although every T Mobile subscribers could have left presumably left T-Mobile for ATT at any point over the 4 years, as the author did when the product was first unveiled).

Sprint, contrary to popular belief, is actually a winner. T-Mobile will receive a $3 billion breakup fee from AT&T if the deal is not consummated for any reason, including because of a failure to get regulatory approval. This means that ATT is wholly committed to getting whatever they need to do to get approval from the Department of Justice and from the FCC. They will sell spectrum and even customers to Sprint at a substantial discount in order to get this deal done. Be warned, do NOT touch the stock. Sprint can be a winner in this transaction and still not be viable as a going concern over the longer term.

What about ATT? ATT could easily be a winner in this acquisition because size matters and there are real efficiencies of scale in the wireless area. They could also be a winner if they could figure out how to monetize their customer base in ways beyond those that they are currently exploring. But, it is also same company that mistakenly thought that it (and not Apple) invented the IPhone before they realized that they were losing money with each incremental subscriber by over-subsidizing the device. A new IPhone 5 over the summer could lead to real expenses for ATT as it over-subsidizes its current subscriber base to prevent churn and further migration to Verizon. In short, ATT management's understanding of the wireless industry is imperfect and leave the very real possibility that it will bungle most of the advantages that this acquisition should provide.

Many shorts have recently piled in to ATT hoping that the company will cut their dividend in order to pay for the acquisition. Those who are shorting the stock for this reason are running a very real likelihood of getting burned. The company is not going to need to pay for the acquisition for at least another year to 18 months. When they do pay, only $25 billion will need to be paid in cash (ATT has an option to pay an additional $4.2 billion in cash instead of equity). ATT has already lined up a $20 billion facility from JP Morgan to cover most of the cash expense associated with the acquisition.

The company’s recent results certainly could lead investors to believe that the dividend will be vulnerable at some point after the acquisition in late 2012 or 2013. In 2010, the company earned approximately $135 billion between the wireless and landline businesses. It had net earnings of $20 billion. The company invested $20 billion in infrastructure, and will undoubtedly be increasing this expense. It also paid almost $10 billion in dividends (which would need to rise by as much as $1 billion to cover dividends to shares issued to Deutsche Telecom), and spent approximately $3.5 billion servicing almost $60 billion in debt (after the acquisition, debt service charges will rise by at least $1 billion). The company had less than $1 billion on hand at the end of 2010 and approximately $13 billion in receivables.

I believe that the company will sell approximately as much as $15 billion of its assets to Sprint and other carriers in 2012 in order to win FCC and DOJ approval. This cash could be used to secure the dividend through at least 2014 even if ATT doesn't grow its revenue over the next two years.

Full Disclosure: The author wouldn’t dream of going long or short ATT, and certainly wouldn’t short it expecting a cut in the dividend. He also wouldn’t dream of going long or short Sprint. He is long Verizon, Deutsche Telecom and Apple.