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» BGOV ANALYSIS Aug. 4, 2014

Would Regulators Approve a Sprint–T-Mobile Merger?

BY KEN MONAHAN TONY COSTELLO Senior Policy Analyst, Technology Director of Government Affairs Research

BGOV OUTLOOK Sprint Corp. and T-Mobile US Inc. are reportedly discussing the outlines of an agreement that would merge the third- and fourth-largest U.S. wireless carriers. An offer could come in September, though Iliad SA’s reported $15 billion offer to acquire 56.6 percent of T-Mobile could accelerate Sprint’s bid. Click for more background

Here are the top five reasons why BGOV projects a less-than-even chance that U.S. regulators would approve the merger:

1. Sprint and T-Mobile’s coverage areas largely overlap, most noticeably in urban areas, and thus a merger could reduce competition.

2. A Sprint – T-Mobile merger could disrupt the broadcast incentive spectrum auction expected to take place in the middle of next year, which may offer for purchase 84 MHz of highly valued low-band spectrum.

3. Justice Department and Federal Communications Commission officials have publicly voiced skepticism about wireless industry consolidation. FCC Chairman Tom Wheeler said in December that “the mobile business is today, with four carriers, a competitive business, and it’s important it stay that way.”

4. T-Mobile’s strong second-quarter financial results may undermine the argument that a merger is necessary to prevent the company’s demise as a standalone carrier.

5. Iliad’s offer, even if rejected by T-Mobile, may confirm for U.S. regulators that there are alternative merger options that would maintain four independent wireless carriers. Dish Network Corp. has also said that it would have a “strategic interest” in T-Mobile if a Sprint – T-Mobile merger were blocked by regulators. Click for more detail on our outlook

Any merger would require approval by DOJ and the FCC. Regulatory reviews may take six months or longer; Sprint is preparing for an approval process that could take at least 12 months. Click for more detail on the regulators

FOR AND AGAINST REGULATORY APPROVAL Those with Skin in the Game

© FOR » Sprint and T-Mobile

» John Paulson (hedge fund manager, fourth-largest holder of T-Mobile stock and third-largest holder of Sprint stock)

» Competitive Carriers Association (represents Sprint, T-Mobile and smaller U.S. carriers; likely to support)

ª AGAINST » AT&T (likely), Verizon (likely), Dish Network (likely), Iliad (likely)

» Communications Workers of America

» Free Press and Public Knowledge (nonprofit organizations)

» Susan Crawford (visiting professor at Harvard University, former telecommunications policy adviser to President Barack Obama)

In Their Words

© Dan Hesse, Chief Executive Officer, Sprint “Right now, the issue that you have in the U.S. wireless industry is that it really is a duopoly where you have 84 percent of the Ebitda and basically 100 percent of the free cash flow out of two large companies, so I think the industry would be healthier—you’d have healthier competition with a stronger No. 3.” – May 6 Bloomberg TV interview

ª Susan Crawford “No matter how the deal is conditioned it would cause a reduction in competition. A new, larger entity will have less incentive to be disruptive and more incentive to raise prices than either Sprint or T-Mobile do now as separate businesses. Both Sprint and T-Mobile already enjoy low costs and underused networks; combining would not lower their costs.” Click for more public statements

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Aug. 4, 2014

OVERVIEW Sprint – T-Mobile Merger » A Sprint – T-Mobile US merger would combine the third- and fourth-largest U.S. wireless carriers. Sprint is reportedly

seeking to acquire T-Mobile for about $32 billion, or about $40 per share.

» Reports indicate that Sprint would offer T-Mobile a $1 billion breakup fee if a deal isn’t consummated, much less than the $4 billion AT&T Inc. paid Deutsche Telekom AG in cash and mobile assets after an AT&T – T-Mobile merger was opposed by regulators in 2011.

» An offer may be formally announced in September, and a merger would require regulatory approval. Department of Justice and Federal Communications Commission reviews typically take 12 months or longer.

x DOJ’s review would focus on whether a merger would reduce competition in the U.S. wireless industry.

x The FCC’s inquiry would be much broader because it would focus on the extent to which a merged company would be in the public interest, a more open-ended standard.

Key Facts: U.S. Wireless Market » The U.S. wireless market is currently dominated by two carriers, Verizon Communications Inc. and AT&T.

» Verizon reported 104.6 million wireless prepaid and postpaid subscribers in the second quarter of 2014 (about 34 percent of total U.S. wireless subscribers, and a 1.3 percent increase compared to the first quarter), and AT&T had 85.7 million subscribers (about 28 percent of all U.S. subscribers, and a 0.7 percent increase over the first quarter).

» Sprint reported 45.4 million wireless prepaid and postpaid subscribers in the second quarter (about 15 percent of all U.S. subscribers, and a 1.9 percent decrease compared with the first quarter), and T-Mobile had 40.2 million subscribers (about 13 percent of all U.S. subscribers, and a 2.6 percent increase over the first quarter, more than any other major carrier).

» Verizon’s and AT&T’s wireless businesses are more profitable, though Sprint and T-Mobile have closed the gap somewhat in recent months. In the second quarter, Verizon’s wireless Ebitda margin was 50 percent (compared with 52 percent in the first quarter), and AT&T’s was 35 percent (down from 39 percent). Sprint’s wireless margin was 22 percent (compared with 21 percent in the first quarter), and T-Mobile’s was 29 percent (up from 15 percent).

If Merged, Sprint/T-Mobile’s 85 Million Subscribers Would Rival Verizon and AT&T Millions of prepaid and postpaid subscribers

Source: Bloomberg

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Verizon AT&T Sprint T-Mobile

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BALANCE SHEET Cases for and Against a Merger

IN SUPPORT » A combined Sprint – T-Mobile would provide the customer

scale needed to compete with Verizon and AT&T.

» Sprint and T-Mobile’s combined spectrum holdings are nationwide (even if their existing coverage networks are not); this spectrum would allow a merged company to improve service and broaden its network in areas currently underserved by the two companies, including rural areas (a priority for U.S. regulators).

» Sprint and T-Mobile may continue to struggle as standalone companies, and three strong companies may prove more sustainable than a market with two dominant carriers and two weaker ones. T-Mobile’s “Un-carrier” pricing program, launched last year, does away with service contracts and pays fees when customers terminate rival contracts. It may be disrupting the wireless market and boosting short-term revenue, but could also mask weakness: Though T-Mobile reported positive net income of $391 million in the second quarter of 2014, it was the first time the company had done so since the first quarter of 2013.

» Together, Sprint and T-Mobile could close the so-called performance gap with Verizon and AT&T, offering consumers a better wireless alternative, and thus more, not less, choice.

IN OPPOSITION » Sprint and T-Mobile’s coverage areas largely overlap, and

thus the merger would reduce, not increase, competition (notably in urban areas). According to the Herfindahl- Hirschman Index, the U.S. wireless market is currently moderately concentrated; after a Sprint – T-Mobile merger, the market would be highly concentrated and the merger would be presumed likely to increase market power, based on calculations by Bloomberg Government.

» T-Mobile’s innovative pricing approach is shaking up the wireless market: Verizon, AT&T and Sprint have all cut prices. A combined company would have more incentives to raise, not reduce, prices.

» A Sprint – T-Mobile merger would probably disrupt the broadcast incentive spectrum auction expected to take place in the middle of next year, which may offer for purchase 84 MHz of highly valued low-band spectrum. The FCC approved rules in May that will limit bidding by Verizon and AT&T; but it will revisit these limits if “significant changes in the marketplace structure occur or a proposed transaction is filed with the Commission in the future affecting the top four nationwide providers and their spectrum holdings.”

» Combining Sprint and T-Mobile’s largely divergent networks, technologies and spectrum would be difficult and costly.

IN THEIR WORDS IN SUPPORT: Dan Hesse, Chief Executive Officer, Sprint

In a May 6 Bloomberg TV interview, Hesse wouldn’t comment specifically on a merger with T-Mobile, but spoke to a number of the challenges facing smaller U.S. wireless carriers:

» On the benefits of a larger third U.S. carrier: “Right now, the issue that you have in the U.S. wireless industry is that it really is a duopoly where you have 84 percent of the Ebitda and basically 100 percent of the free cash flow out of two large companies, so I think the industry would be healthier, you’d have healthier competition with a stronger No. 3.” For consumers, “a strong No. 3 will get One and Two to react more aggressively so that everybody benefits. If you are smaller, the Big Two don’t react as significantly or as aggressively.”

» On the impact of price wars on Sprint: “You have a lot of promotions going on in the market right now that consumers see as positive; the real question is how sustainable is that?” Promotion spending “puts stress on us, particularly in the ability to invest in networks.”

» On the challenge of getting a deal approved: “If you read the papers, there are a lot of regulators who are skeptical, so theoretically, if such a transaction were to occur, we would have some convincing to do.”

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Aug. 4, 2014

IN SUPPORT: John Legere, Chief Executive Officer, T-Mobile Legere has refused to comment publicly on a merger, but said in T-Mobile’s July 31 quarterly earnings call that “we have been very successful and we see a path forward to be highly successful as a standalone company, but we also know that we could significantly accelerate that growth and create an even higher level of competition in the U.S. wireless industry by various forms of accelerating this platform. We have multiple versions of things we can do inorganically with this company, and multiple versions of timing as to when we do them.”

IN OPPOSITION: Susan Crawford, Visiting Professor, Harvard Law School “For the same reason the 2011 proposed merger of AT&T and T-Mobile didn’t go through, a Sprint/T-Mobile joinder shouldn’t be permitted. No matter how the deal is conditioned it would cause a reduction in competition. A new, larger entity will have less incentive to be disruptive and more incentive to raise prices than either Sprint or T-Mobile do now as separate businesses.

“If maverick T-Mobile wants to sell out, all it has to do is find a buyer who isn’t a member of the current club. And all Sprint has to do is invest in its networks – as SoftBank Corp. Chairman Masayoshi Son promised. Both Sprint and T-Mobile already enjoy low costs and underused networks; combining would not lower their costs. Sprint rationally wants the market power that will allow it to raise prices and coordinate with the Big Two – much easier with a triopoly.”

BGOV OUTLOOK There’s probably a less-than-even chance that U.S. regulators would approve a merger:

» Sprint and T-Mobile’s coverage areas largely overlap, and thus a combined company could reduce, and not necessarily increase, competition in the U.S. wireless market.

» U.S. regulators have publicly voiced skepticism about wireless industry consolidation. William Baer, Assistant Attorney General of the Justice Department’s Antitrust Division, said in January that “it’s going to be hard for someone to make a persuasive case that reducing four firms to three is actually going to improve competition for the benefit of American consumers,” without specifically mentioning a Sprint – T-Mobile merger.

x DOJ approved a T-Mobile – MetroPCS Communications Inc. merger in March 2013, citing MetroPCS’s lack of nationwide spectrum, networks and scale as reasons why a merged company wouldn’t upend pricing, device offerings and network technology.

x Even so, DOJ filed an antitrust lawsuit in August 2011 to block AT&T’s proposed acquisition of T-Mobile, finding that the merger would have eliminated “a company that has been a disruptive force through low pricing and innovation by competing aggressively in the mobile wireless telecommunications services marketplace.”

» FCC Chairman Tom Wheeler has also expressed concerns about industry consolidation. He said in December that “the mobile business is today, with four carriers, a competitive business, and it’s important it stay that way.”

x Like DOJ, the FCC approved the T-Mobile-MetroPCS merger, concluding that the deal “is not likely to result generally in competitive or other public interest harms.”

x However, in August 2011 then-FCC Chairman Julius Genachowski asked commissioners to set up a trial-like hearing because the agency couldn’t determine that the deal would be in the public interest. In a November 2011 order, FCC staff concluded that the merger “would substantially lessen competition and its accompanying innovation, investment, and consumer price and service benefits.” Combined with DOJ’s filing of its antitrust lawsuit, the FCC’s decision to set up the hearing effectively killed the deal.

» The possibility that a Sprint – T-Mobile deal could disrupt next year’s broadcast incentive spectrum auction may be a reason for the FCC to, at minimum, delay a merger decision, and ultimately reject an agreement.

» T-Mobile’s strong second-quarter financial results may undermine the case that a merger is necessary to prevent the company’s demise as a standalone carrier.

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» Iliad’s offer may confirm for regulators that there are alternative merger options that would maintain four independent U.S. wireless carriers.

Other factors to consider:

» DOJ and FCC’s ongoing reviews of two other major telecommunications merger proposals, Comcast Corp. – Time Warner Cable Inc. and AT&T – DirecTV, may complicate approval of a Sprint – T-Mobile deal as regulators weigh, and inevitably compare, the antitrust and public interest impact of each agreement.

» Whether or not a Sprint – T-Mobile merger is approved, a key for stronger U.S. wireless competition will continue to be capital investment, namely spectrum acquisition and network build-out. The challenge combining Sprint and T-Mobile’s existing infrastructure may hinder further network expansion, thus giving an additional short- to medium-term advantage to Verizon and AT&T.

» If a deal limits the amount of spectrum a merged Sprint/T-Mobile can purchase at auction, the new company may acquire less spectrum than the two companies would be able to obtain individually, further limiting its long-term prospects. Sprint and T-Mobile are reportedly considering bidding jointly during next year’s broadcast spectrum auction, but FCC Chairman Tom Wheeler circulated a proposal Aug. 1 saying that such arrangements between nationwide carriers shouldn’t be permitted during the auction, and he’s asked the other four commissioners to join him in barring them.

THE REGULATORS Justice Department

Key Office: Antitrust Division » The mission of the Department of Justice’s Antitrust Division is to promote economic competition through enforcing and

providing guidance on antitrust laws and principles.

The division enforces U.S. antitrust laws, which prohibit practices that restrain commerce, such as corporate mergers likely to reduce competition in specific markets. It also advocates for competition in federally regulated industries, including agriculture, banking, communications, energy, securities and transportation.

Top Official » William J. Baer, Assistant Attorney General for the Antitrust Division: Baer was sworn into his position on Jan. 3, 2013.

Before his appointment, Baer was a partner and head of the Antitrust Practice Group at Arnold & Porter LLP in Washington, D.C., with extensive experience in both criminal and civil antitrust investigations, including merger and acquisition reviews by antitrust enforcement agencies in the U.S. and internationally. From April 1995 until October 1999, Baer was the director of the Bureau of Competition at the Federal Trade Commission.

DOJ Positions on Recent Wireless Mergers » T-Mobile US Inc.–MetroPCS Communications Inc.: Went into effect in April 2013

x DOJ’s Antitrust Division determined in March 2013 that the T-Mobile – MetroPCS merger was unlikely to harm consumers or substantially lessen competition.

x DOJ cited in a closing statement that MetroPCS’s lack of nationwide spectrum, networks and scale as reasons why a merged company wouldn’t upend plan pricing, device offerings and network technology, which often take place at the national level. DOJ also found that a merger “may have a procompetitive impact in that it improves T-Mobile’s scale and spectrum position, particularly since MetroPCS’s spectrum holdings are compatible with T-Mobile’s existing network.”

» AT&T Inc.–T-Mobile: Abandoned by AT&T in December 2011

x DOJ filed an antitrust lawsuit in August 2011 to block AT&T’s proposed acquisition of T-Mobile, which, combined with a November 2011 request by then-Federal Communications Commission Chairman Julius Genachowski to set up a trial-like hearing to review the merger, effectively killed the deal.

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x In its lawsuit, DOJ said that the transaction would have reduced competition in the U.S. wireless market, resulting in higher prices, poorer service, less choice and fewer innovative products for U.S. consumers. DOJ said in a press release that AT&T’s acquisition of T-Mobile would have eliminated “a company that has been a disruptive force through low pricing and innovation by competing aggressively in the mobile wireless telecommunications services marketplace.”

x DOJ also found that AT&T could “obtain substantially the same network enhancements that it claims will come from the transaction if it simply invested in its own network without eliminating a close competitor.”

Key for Sprint and T-Mobile » Sprint and T-Mobile would need to persuade DOJ officials that a merger wouldn’t substantially reduce competition, among

other considerations.

Federal Communications Commission

Key FCC Offices » FCC leadership: The Federal Communications Commission’s five commissioners are appointed by the president and

confirmed by the Senate for five-year terms. Commissioners vote to approve mergers, and defer some decisions to commission bureaus, e.g., the Wireless Telecommunications and International bureaus.

» Wireless Telecommunications Bureau: The bureau develops and executes policies and procedures for fast, fair licensing of all wireless services, including mobile broadband services. The bureau would, at minimum, provide advice to FCC leadership on a Sprint Corp. – T-Mobile US Inc. merger.

» International Bureau: The bureau administers international telecommunications and satellite programs and policies, and would also, at minimum, provide advice to leadership on a merger, given Sprint and T-Mobile’s non-U.S. ownership.

Top FCC Officials » Tom Wheeler, FCC Chairman: Wheeler was confirmed by the Senate in October 2013, and became the 31st chairman of

the FCC in November. Before joining the FCC, Wheeler was managing director at Core Capital Partners, a venture capital firm investing in early stage Internet protocol-based companies. He previously served as president and CEO of the National Cable Television Association (NCTA) and the Cellular Telecommunications & Internet Association (CTIA).

» Mignon Clyburn, Democratic Commissioner: Clyburn served as acting chairwoman of the FCC from May 2013 until November, when Wheeler was sworn in. She is serving her second term as commissioner, having originally been confirmed by the Senate in August 2009. Before joining the FCC, Clyburn spent 11 years as a member of the Public Service Commission of South Carolina.

» Jessica Rosenworcel, Democratic Commissioner: Rosenworcel was confirmed by the Senate and began her service in May 2012. Before joining the FCC, she served as Senior Communications Counsel for the Senate Committee on Commerce, Science and Transportation under chairmen John D. Rockefeller and Daniel K. Inouye. Previously, Rosenworcel served as legal adviser to former FCC Commissioner Michael J. Copps.

» Ajit Pai, Republican Commissioner: Pai was confirmed by the Senate and began his term in May 2012. Before his current FCC service, Pai was a partner in the communications practice at Jenner & Block LLP. He previously held several positions in the FCC’s Office of General Counsel, including serving as deputy general counsel.

» Michael O’Rielly, Republican Commissioner: O’Rielly was confirmed by the Senate in October 2013 and was sworn into office in November. Before joining the FCC, O’Rielly served as a policy adviser in the Office of the Senate Republican Whip, led by Senator John Cornyn, and held numerous other positions in the Senate and the House of Representatives.

» Roger Sherman, Chief, Wireless Telecommunications Bureau: Sherman has been chief of the Wireless Telecommunications Bureau since November 2013. Before joining the FCC, he served as Democratic chief counsel to the House Committee on Energy and Commerce and Democratic staff director to its Subcommittee on Communications and Technology. He previously held numerous other positions in the House and in the private sector.

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» Mindel De La Torre, Chief, International Bureau: De La Torre has served as chief in the International Bureau since October 2009. Previously, De La Torre was president of the Telecommunications Management Group Inc., a Washington, D.C.-based consulting firm, where she advised businesses, international organizations and regulators on telecommunications issues. She served as the FCC’s deputy chief in the International Bureau from 1994 to 1998.

FCC Positions on Recent Wireless Merger Cases » T-Mobile – MetroPCS Communications Inc.: Went into effect in April 2013

x The FCC published an order and declaratory ruling on March 12, 2013 approving the T-Mobile – MetroPCS merger.

x The FCC found that the merger “is not likely to result generally in competitive or other public harms.” The agency said that any negative impact on competition in selected geographic areas would be outweighed by public interest benefits, including the “facilitation of Long Term Evolution (“LTE”) deployment, the expansion of the MetroPCS brand into new geographical markets, the development of a more robust, national network, improved quality of service, and the strengthening of the fourth largest nationwide service provider’s ability to compete in the mobile broadband services market.”

» AT&T Inc. – T-Mobile: Abandoned by AT&T in December 2011

x In November 2011 then-FCC Chairman Julius Genachowski asked commissioners to set up a trial-like hearing because the agency couldn’t determine that the deal would be in the public interest. Combined with the Department of Justice’s August 2011 filing of an antitrust lawsuit to block the merger, the FCC’s move effectively killed the deal.

x In an order published in November 2011, FCC staff concluded that the deal “would substantially lessen competition and its accompanying innovation, investment, and consumer price and service benefits.” Staff also found that AT&T and T- Mobile “failed to meet their burden of proof to show that the proposed transaction is in the public interest.”

Key for Sprint and T-Mobile » It would be critical to convince FCC officials that a merger would actually give consumers more choice than they have right

now, boost investment and prevent the demise of Sprint and T-Mobile as standalone carriers, among other public interest considerations.

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ANALYST CONTACT INFORMATION Ken Monahan, Senior Policy Analyst, Technology [email protected] +1 202 416 3424

ABOUT THE ANALYST

Ken Monahan is a Senior Policy Analyst, Technology with Bloomberg Government. He was an international economist and acting team lead in the Office of Trade Policy Analysis at the Commerce Department’s International Trade Administration. He holds a B.A. in economics from the University of New Hampshire, an M.A. in central and eastern European studies from Jagiellonian University in Krakow, Poland, and an M.A. in international relations from the Johns Hopkins School of Advanced International Studies. He was a Fulbright Fellow in Vilnius, Lithuania. Follow Ken on Twitter: @KenMonahanDC

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