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Merger talks between T-Mobile USA – a subsidiary of Deutsche Telekom AG (DTEGY)and low cost carrier MetroPCS Communications, Inc. are hitting the headlines again. However, this time it comes straight from the horse’s mouth. Both MetroPCS and Deutsche Telekom recently confirmed their merger talks, though no deal has been finalized yet.

The market showed a positive initial reaction to the report, taking the MetroPCS stock up 17% to $13.57 on October 2nd closing.  The share price has since come down, but remains above trading levels before the announcement.

The news of the merger between the companies first surfaced in May this year when Bloomberg reported that Deutsche Telekom was in discussions with MetroPCS for a possible merger with its U.S. wireless unit – T-Mobile USA.

Around the same time, it was also reported that the deal would entail a stock swap between the two parties. This would enable Deutsche Telekom to gain a majority of the controlling power in the combined entity, which would be publicly traded. 

Much Ado About Telecom M&As

The recent years have been a booming period for the telecom market with rapid expansion in the wireless space. According to market sources, the wireless industry contributed over $195 billion to the U.S. GDP in 2011 and this is expected to reach approximately $1.5 trillion over the next ten years.

Globally, market capitalization of wireless services stand at around $61 billion and is expected to touch approximately $155 billion by 2016 with a growth rate of about 20%.  A major share of this growth story is attributed to the insatiable demand for wireless data services. 

According to CTIA reports, the U.S. wireless data traffic grew approximately 123% to 866.7 billion MB in 2011 from 388 billion MB in 2010. CTIA reports also suggest that the number of smartphone users has also leaped 43% to 111.5 million in 2011 from 78.2 million in 2010. This has led to an inevitable growth in wireless data traffic. However, managing this data traffic requires additional spectrum, which is currently the biggest concern for the wireless industry.

Wireless carriers are in the fray to obtain spectrum licensing and lure customers with deploying 3G and 4G services across their markets. As spectrum remains limited, the fight over it is intensifying. Smaller carriers like MetroPCS are failing to cope with industrial bigwigs given huge capital requirements. As a result, the best way to deal with spectrum constraints for these low cost carriers is to form a suitable liaison that will enable them to withstand the competitive market.

Recent Acquisition Attempts

In 2011, the news of $39 billion merger of AT&T Inc. (T - Analyst Report) and T-Mobile USA took the wireless market by storm. It would have been the biggest deal ever, consolidating AT&T’s position as the largest U.S. wireless carrier dethroning Verizon Communications Inc. (VZ - Analyst Report). However, the much awaited deal ended in a disaster. Following a nine-month fight to win approvals, the deal was dropped by AT&T.

The Federal Communications Commission (FCC) cited concerns of unfair competition, layoffs, higher prices, lower innovation and investments in the industry.  Further, the deal was opposed by the third-largest U.S. wireless carrier Sprint Nextel Corp. (S - Analyst Report) as the combined company would have been almost three times that of Sprint, and consequently, would hurt its profitability.

Following the AT&T/ T-Mobile merger fall out, speculations over Sprint and Metro PCS merger were also making rounds early this year. However, this deal too did not materialize as Sprint’s Board of Directors rejected the proposition. 

Outcomes from T-Mobile

Given the recent history of failed M&A deals, we remain somewhat skeptical over the news. Deutsche Telekom had previously stated that merging with the smaller company was not a choice, but the only option.

However, after the failed attempt of Deutsche Telekom to collaborate with U.S. telecom czar AT&T, it has not lost hope on tapping potential future opportunity in the U.S. market. This contemplated deal is another effort by the company to strengthen its position in the U.S and save falling subscriber numbers.

Previously, it was also rumored that Deutsche Telekom is viewing other viable options such as launching IPO or sale of T-Mobile USA. In fact, the company’s talks with other companies’ carries in the U.S. also made the market buzz. 

However, given the nature of the recent merger talks, we think that it does not call for any regulatory threat. As per reports, T-Mobile and Metro PCs hold market penetration of approximately 9% and 2%, respectively. As a result, we do not foresee similar concerns surfacing as in the case of AT&T Inc and T-Mobile failed merger.

Upon execution, we expect the deal to be accretive to MetrPCS given its alliance with the fourth-largest wireless operator following Verizon, AT&T and Sprint. However, how much benefit T-Mobile would draw from the “in talks” deal is something to wait and watch for.

We are currently maintaining our long-term Outperform rating on MetroPCS with a Zacks #1 Rank (Strong Buy).

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