Deutsche Telekom's Achilles' Heel
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T-Mobile USA has been in rough shape these last few years, especially after the takeover attempt by AT&T (NYSE: T) failed. They have been losing customers consistently and it is an open secret that their parent company, Deutsche Telekom, is not happy with T-Mobile’s performance.
T-Mobile makes up roughly 25% of Deutsche Telekom (NASDAQOTH: DTEGY.PK) and thus is large enough that Deutsche Telekom needs good performance from its American network to be a successful company overall. T-Mobile also does not have a 4G LTE network or the iPhone at this time and is the fourth largest wireless carrier in the United States, putting it behind all of the big names: Verizon, AT&T and even Sprint (NYSE: S).
However in the most recent set of quarterly results, T-Mobile USA’s operating profit was up 13% due to lower device subsidization costs and they added net customers. T-Mobile is undergoing a transformation at the moment; planned or not once it is complete there is a possibility that T-Mobile will emerge as a competitive wireless company, whether they are still a subsidiary of Deutsche Telekom or an independent company.
In this latest quarter T-Mobile added net customers, however it was not the traditional contract customer. The net increase of over 100,000 customers in the first quarter came from a huge increase in pre-paid customers, who are not as lucrative as traditional contract customers. This large increase in pre-paid customers going forward will be able to compensate at least mostly for the slow loss of contract customers. Pre-paid customers are not the most optimal type of customers, but adding hundreds of thousands of them isn’t bad and T-Mobile, which has over 33 million customers, hasn’t made any hugely expensive technology bets that didn’t pan out, like Sprint did with WiMax.
On the issue of 4G, T-Mobile has also announced that they are contracting with Nokia Siemens and Ericsson to roll out LTE by 2013. The T-Mobile LTE roll out has been allotted $4 billion, though how much each contract company is getting has not been disclosed. This will allow T-Mobile to be competitive with the other carriers in the future and their HSPA+ network -- which they currently brand as 4G and which is faster than 3G -- will allow them to compete this year.
Another avenue of business for T-Mobile is from virtual network operators, who use the T-Mobile network but sell their own devices on it and offer their own support. This allows T-Mobile to operate more as a pipe for connectivity and less as a cell phone provider. There are slimmer margins when T-Mobile sells wholesale to a virtual network provider, but there are also fewer costs -- T-Mobile only has to maintain their network, and they don't deal directly with customers. Simple Mobile and a number of other virtual operators already use T-Mobile as their network provider. T-Mobile recently rolled out an exclusive deal in Wal-Marts across the country offering 5GB of data, 100 minutes of talk and unlimited texting for just $30 a month with no contract. T-Mobile has further embraced their no-contract future with their new of 4G broadband plans launched on May 20 that are competitively priced and also do not lock customers into a two-year commitment.
After the AT&T-T-Mobile take over fell through rumors have been swirling about what Deutsche Telekom plans to do with T-Mobile USA. One rumor reported by Bloomberg is that Deutsche Telekom is considering a stock swap deal that would combine T-Mobile USA and Metro PCS (NYSE: TMUS). Metro PCS is a major player in the pre-paid cell phone market and has been making a name for themselves by investing in a LTE 4G network and offering a range of affordable Android devices. According to the rumor Deutsche Telekom would remain the majority shareholder in the combined company with the potential for a future IPO.
This merger would present a technical issue as T-Mobile uses GSM technology for their 3G network and Metro PCS uses CDMA technology for their 3G networks, though both are planning on using LTE for 4G. This merger would give T-Mobile a further edge in pre-paid customers and would not come under the anti-trust scrutiny that the AT&T T-Mobile merger did. Metro PCS has proven over the past few years and with a customer base over nine million that the pre-paid model can be successful. However we saw with the Sprint Nextel merger the long term challenges of merging two cell phone companies who use different network technologies.
Regardless of whether this merger comes to fruition the future of T-Mobile USA is in pre-paid customers and wholesale products through virtual network operators and exclusive deals like T-Mobile has with Wal-Mart. This will prove to be successful for T-Mobile going forward as the percentage of pre-paid smartphones has roughly doubled from a few years ago and continues to grow quickly. Verizon and AT&T have not embraced this pre-paid market as much because there is less guaranteed profit with no long term contracts, so T-Mobile has an opportunity to become a leader in the pre-paid market. With a merger with Metro PCS Deutsche Telekom could reduce the financial risk they face from the US market while still remaining a player.
However this strategy is a long shot. Sprint currently dominates the pre-paid market and AT&T, Verizon and Sprint are adding hundreds of thousands of customers per quarter. Additionally Sprint owns several niche virtual network operators such as Virgin Mobile that put Sprint in a better position than T-Mobile in terms of pre-paid and non-traditional customers. Though T-Mobile USA will not vanish in the future, they will not be taken over and they should not merge with a smaller carrier like Metro PCS unless they use more homogeneous wireless technology. T-Mobile USA will continue to survive in fourth place and their best shot at success is to diversify into a wholesale wireless ISP to virtual network operators who cater to niche markets, which will provide a secondary business to complement their traditional T-Mobile branded service.
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