I just finished reading an op-ed piece in the Florida Courier suggesting the merger between AT&T (NYSE:T) and T-Mobile is good for America. It states that AT&T will create 100,000 jobs and make wireless service available to most of the country. That’s a can’t-lose marketing pitch if there ever was one.
Fortunately, the Department of Justice sees through this con job and has stepped in to prevent the deal from happening. AT&T shareholders might want to take the time and reflect on what this merger really means: Higher prices and even worse customer service. This deal is bad for AT&T, and it’s bad for America. Sell your stock before this gets messy. While you’re at it, I suggest you look at CenturyLink (NYSE:CTL) instead.
Merger Savings
According to The Wall Street Journal, the merged businesses will save $40 billion in costs, and thousands of jobs likely will be lost in the integration. That’s a different picture than the one I read about in the Florida Courier. The simple fact is that AT&T is eliminating the T-Mobile name altogether, and with it, the retail stores that sell T-Mobile phones. They might bring back 5,000 customer service jobs from offshore, but that’s a long way from 100,000.
I live in Canada where, until recently, there was very little competition in the wireless industry, with three companies dominating business. Despite recently increased competition, Canadians aren’t seeing the benefits. Canada has gone to a more competitive environment where consumers are gaining little, yet the U.S. is going to move the other way — become less competitive and expect things to get better. That’s not happening. AT&T shareholders might see this as the road to higher profits, but it could just as easily be the road to ruin as loyal T-Mobile customers flee for Sprint (NYSE:S) and Verizon (NYSE:VZ).
Merger Costs
AT&T is paying $39 billion for T-Mobile, with $25 billion in cash and the rest in stock. With approximately $3.8 billion in cash on its balance sheet, it’ll have to borrow $21 billion to make it happen. This will up AT&T’s total debt to $87.6 billion and its debt ratio from 36.8% to 66.4%. AT&T paid 7.1 times T-Mobile’s 2011 EBITDA of $5.5 billion, which puts its total debt at two times EBITDA for the combined businesses. Its current debt covenants allow for a maximum of three times debt.
While it’s within its covenants, I can see why Fitch is keeping an eye on it. These are the obvious costs. The less obvious costs are the hours AT&T senior management will spend trying to defend the defenseless. The deal’s original closing is the first quarter of 2012. It won’t come close. If the deal does happen, a second-half closing seems more realistic. If the deal doesn’t go through, AT&T owes T-Mobile and Deutsche Telekom a $3 billion breakup fee along with $3 billion in wireless spectrum. A $6 billion tab is a lot to pay for reckless ambition.
Both AT&T and T-Mobile claim the DOJ lawsuit caught them off guard. If this is true, AT&T investors have a lot to worry about, including a C-Suite that isn’t very prepared. I guess they weren’t boy scouts when they were young.
We’re No. 3!
CenturyLink is the third-largest telecommunications company in the U.S. behind AT&T and Verizon. While AT&T’s acquisition seems to be about improving its wireless network, CenturyLink’s acquisitions, on the other hand, are more about revenue diversification. Through its purchase of Savvis and Qwest, 60% of its revenue now comes from business customers. CTL is reducing its exposure to regulated revenues, and that should improve its free cash flow generation.
CenturyLink’s free cash flow yield as of Oct. 7 is 9.7% — 130 basis points higher than AT&T. In addition, its free cash flow is 2.5 times net income in the trailing 12 months compared to 0.69 times for AT&T. Why is this so important? CenturyLink pays a $2.90 dividend (9% yield), and it’s comforting to know CTL generates plenty of free cash to pay the darn thing. Century Link’s stock might not be extremely cheap right now, but it is down 25% year-to-date — the worst performance since implementing a bigger dividend in 2008. Sometimes, it’s good to be No. 3.
Bottom Line
Why do companies continue to swing for the fences when singles and doubles will get the job done? Because they can. Not every acquisition is a bad idea, but AT&T’s is — no matter how it attempts to spin it.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.
