Consolidating the Pre-Paid Masses

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After AT&T’s (NYSE: T) $39 billion failed bid to merge with T-Mobile last year, a deal squashed by anti-trust concerns, Deutsche Telekom has decided to stay in the U.S. market by first leasing off a portion of its tower network to Crown Castle for $2.4 billion up front and a potential $2.4 billion balloon payment in 2048, if we all live that long.  T-Mobile’s agreement with Crown Castle also includes a $250 million breakup fee, which reaffirms that the Crown Castle deal will go ahead with or without MetroPCS.

By doing this, they raise the cash to then merge with the much smaller MetroPCS Communications (NYSE: TMUS), whose subscriber base will expand T-Mobile’s 33.2 million by 28%.  T-Mobile, along with AT&T, are the only two major GSM carriers in the U.S., while MetroPCS is CDMA. 

So, at first blush this seems an odd couple.  But the world is moving away from the older 2G technology towards LTE, and MetroPCS is the first U.S. carrier to offer VoLTE (Voice over LTE); that is where this deal makes sense, along with their operating on the same 1700/1900 MHz frequencies. So, while the transition from one technology to the other takes place, T-Mobile will have to eat some roaming fees. In 2013 T-Mobile will slowly shut down the old 2G/3G networks, and MetroPCS will quit selling CDMA phones and move subscribers over to GSM.  The conversion will be complicated but ultimately easier than it sounds at first.  A recent interview with T-Mobile’s Neville Ray outlines the plan

Both Verizon (NYSE: VZ) and AT&T have dragged their heels on implementing VoLTE, as it will hasten the demise of their charging outrageous sums for package minutes along with data.  It’s the same fear the cable companies have: being dumb wires, or in this case, dumb frequencies just carrying data while all of the nickel-and-dime services (where a great deal of revenue is generated) go to the some cloud-based service provider.   

This has big implications for Microsoft’s (NASDAQ: MSFT) Windows Phone and Skype, as it will give them a second carrier to provide cheap data without a contract.  T-Mobile and MetroPCS both specialize in low-cost no-contract data services and this is why this deal is so important.  And this is where all the sales growth in smart phones is in the U.S.  Simply put, the U.S. market is slowly morphing into the rest of the world.  And T-Mobile/MetroPCS looks to be a winner while AT&T and Verizon continue to cater to the enterprise set.

With Sprint dragging its heels on supporting Windows Phone 8, the bevy of no-contract providers in the U.S. all carry almost exclusively Android phones.  Yes, Verizon is on board the WinPhone train but Sprint won’t have anything before the end of Q1 2013 at the earliest.  As smartphones push to cheaper entry-level price points, being able to compete in that portion of the market is important if Microsoft is serious about gaining market share.

According to NPD’s latest report, smartphone sales grew 9% in Q2, but all of the growth was in pre-paid phones.  They also noted that the income level of the average buyer is shifting down, with 71% of buyers earning less than $35,000 per year.  A $100 smart phone on a $35 per month plan has a huge value proposition over a $200 iPhone on a $110 per month two year contract.  This is where last generation Nokia and HTC phones will continue to sell.  

Financially, it look like MetroPCS will have 25% of ownership of the merged company and will remain the only major telecom company that doesn’t fully support Apple’s iPhone, as neither network operates at 1900MHz.  Unlike AT&T’s attempt, this bid is expected to get the regulator’s approval quite quickly, as T-Mobile will still be the fourth largest network in the U.S.  The advantages are simply that the two companies are better together than apart in the coming country-wide LTE deployment and grab for the untapped low end of the smartphone/VoIP market.

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