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D.Telekom JV could jump Sprint hurdles

September 14, 2009

ATHLETICS/Deutsche Telekom is struggling in two of its most important international markets and desperately needs to find a quick fix. Its proposed joint venture with France Telecom is a graceful way to establish a leading position in the UK market. But buying Sprint Nextel in the United States looks far less sensible.

A takeover of its rival would catapult Deutsche Telekom past AT&T and Verizon to U.S. number one position. However, the deal looks a costly way to get its operations there growing again. Talk of a bid for Sprint Nextel by T-Mobile USA — the business Deutsche Telekom acquired when it bought VoiceStream in 2000 — is hardly new.

But Monday’s fall in the German company’s share price on the latest report that it is looking at a bid suggests investors still have misgivings about the idea.

After all, Deutsche Telekom forked out $25 billion in shares and cash to buy VoiceStream at the top of the market, piling on debt which almost brought the telecoms group to its knees but failed to deliver the major market presence it wanted. Its strategy since then has been all over the place. It first looked at selling  the U.S. business, before apparently changing tack by considering buying a rival.

It’s no wonder investors are jittery. For while a combination of T-Mobile USA and Sprint Nextel could address some of the problems, the cost to Deutsche Telekom would be huge. Sprint Nextel, itself formed through a merger at the end of 2004, is heavily leveraged: its net debt of $20bn is almost double its market capitalisation of $11 billion. But Deutsche Telekom, which is valued at around $60 billion, is already carrying net debt of nearly $65 billion (as of June 30).

Any takeover would also require a premium of, say, 25 percent to win over Sprint Nextel’s shareholders. Persuading Deutsche Telekom’s shareholders — including German state lender KfW with nearly 17 percent of the company and the German government with almost 15 percent — to throw yet more money at the U.S. in an effort to make up for past mistakes would be a hard sell.

Loading more debt onto the combined business might also prove a stretch. Any takeover of Sprint Nextel would almost certainly hit Deutsche Telekom’s credit rating, which Fitch recently lowered to BBB+.

Then there is the technological challenge. A combined T-Mobile USA and Sprint Nextel would have three networks, each using very different technologies. In time, the combined company could reap cost savings by switching to 4G technology, but it is hard to see a takeover providing Deutsche Telekom with the quick fix it needs.

Rather than a takeover, Deutsche Telekom should consider instead a joint venture similar to the deal it struck with France Telecom in the UK. Injecting T-Mobile USA into Sprint Nextel would bring all the benefits of a combination without the costs of a takeover.

Such partnerships can be complicated, but they can work: Verizon and Vodafone have a long-standing partnership in the U.S. mobile business. At least, adopting the UK model would save Deutsche Telekom’s shareholders another expensive U.S. acquisition while giving it an elegant exit route.

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