Incumbent German telecom carrier Deutsche Telekom (DT) is evaluating the acquisition of Sprint Nextel (S), the third largest US carrier. The company has reportedly initiated discussions and may submit a bid in the coming weeks. Deutsche Telekom operates in the US through its subsidiary T-Mobile USA, which is the fourth largest US wireless carrier, with 33.5 million subscribers.

Sprint has a current market valuation of $10.8 billion with a total debt position of approximately $21 billion. In order to finance the potential multi-billion dollar deal, Deutsche Telekom may need to seek funding from its shareholders Incorporatedluding the German government, which holds 32% stake in the company.

Deutsche Telekom is pursuing several initiatives to revive its struggling business operations across Britain and the US. The company has recently announced the merger of its British subsidiary T-Mobile UK with France Telecom’s (FTE) Orange UK which will create the largest wireless operator in the UK with roughly 37% market share. Deutsche Telekom aims to emulate its strategic approach in the UK by combining T-Mobile USA with Sprint.

T-Mobile USA is contending in an increasingly consolidating industry. Verizon (VZ) has become the number one wireless carrier in the US after its consolidation with Alltel Corp in early 2009 while AT&T (T) is set to acquire Centennial Communications Corp (CYCL), the ninth-largest wireless service provider in the US. As such, T-Mobile USA is becoming increasingly isolated.

Due to their size and scale of operations, T-Mobile USA’s larger competitors are able to deliver services in a more cost-efficient manner, which is affecting the company’s position in the market. T-Mobile USA’s market share reduced to approximately 12% at the end of 2008 from 15% registered in 2007.

T-Mobile USA added just 325,000 new customers compared to 1.4 million and 1.1 million added by AT&T and Verizon, respectively. The company’s weak performance has partly contributed to Deutsche Telekom’s downward revision of earnings forecast for 2009.

Like T-Mobile USA, Sprint Nextel is also struggling with persistent subscriber retention problems as it continues to lose customers to its larger competitors as well as smaller peers due to intense price competition. The company’s postpaid customer base continues to shrink with nearly 2.25 million customers lost in first-half 2009.

The potential integration of Sprint Nextel and T-Mobile USA would create an entity which will be better positioned to compete with Verizon and AT&T. The combined company will benefit from cost synergies and will have a wireless customer base of approximately 78 million, thereby significantly challenging the second-placed AT&T, which has 79.6 million subscribers.
However, the merged company will face network integration problems, as Sprint Nextel operates iDEN and CDMA wireless networks that are incompatible with T-Mobile USA’s GSM based network.

Moreover, Sprint’s 3G network is based on EVDO technology compared to the HSPA 3G standard based network deployed by T-Mobile USA. This may result in significant costs to transition cellular users to a common network technology. Thus we remain skeptical about the potential outcome of the deal, if it eventually materializes.

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