EC Why Regulators Might Welcome A T-Mobile US – Sprint Merger

In light of the recent news around renewed merger talks between T-Mobile US (TMUS) and Sprint (S), we have read a lot of discussion about the regulatory risk in such a transaction. It seems that a majority of observers believe a deal will be hard to get done.At first blush this is understandable. After all, regulators blocked the 2011 merger attempt between AT&T and T-Mobile US and the 2014 merger attempt between T-Mobile US and Sprint, both times for the same reason. They wanted to preserve the status quo of four national competitors rather than see a decline to three national competitors.

There was a time when there was a sound industrial logic behind these regulator objections. Reducing four competitors to three might have led to price increases and hurt consumers if it had happened 10 years ago. We believe, however, that the facts today no longer support these objections. Below, we will identify four structural changes in the wireless industry that have substantially increased competition in recent years. We note that a lot of these changes came into full effect after regulators rebuffed T-Mobile US and Sprint’s previous merger attempt, and are still ongoing today.

In our view the facts suggest that the US wireless industry would be more competitive with three national players today than it was with four national players as recently as five years ago. Moreover, as we will discuss below, it seems unlikely that consumer prices will increase as a result of this merger. So in the spirit of John Maynard Keynes, “when the facts change, regulators should change their mind.”

We go one step further, and argue that a T-Mobile US – Sprint merger has the potential to deliver significant benefits to consumers by increasing competition in several adjacent markets, specifically in the pay television and broadband internet markets. Unlike wireless services pricing, which has been in a steep and accelerating decline in the last decade, pricing for traditional television bundles has increased faster than the overall rate of CPI inflation. And on the broadband internet side, many households in America today have only one or two options for broadband internet access. We explain why a merged T-Mobile US – Sprint would be in a superior position to disrupt these less competitive markets, and ultimately lower prices for consumers.

Thus, while we do not believe meaningful consumer negatives are likely in the wireless market, we see the potential for significant consumer benefits in the pay television and broadband internet markets. The lines between internet access services (of all kinds), telephony services, and media / content services have been blurring for some time, and there is a distinct trend towards converged offerings of all of these services. When viewed in the context of a broader market definition encompassing all these services, we believe it is difficult to escape the conclusion that a merger between T-Mobile US and Sprint will increase competition and benefit consumers.

In other words, when viewed in a more appropriate, broader context, regulators might welcome a deal, rather than block it.

Structural Changes in the US Wireless Market

We begin with a high level view of historical CPI inflation in the US wireless market compared to the overall CPI and the CPI for pay television and internet services. We begin the comparison in June 2007, when Apple introduced the original iPhone, marking, in our view, the beginning of the modern wireless era.

Source: Bureau of Labor Statistics

Several points stand out. First off, wireless services are the only category for which prices have actually declined in the last decade.In fact the decline has been a rather substantial 26%. Secondly, and perhaps more importantly, there has been a marked acceleration in price declines recently. The recent declines have been so rapid that the Federal Reserve called them out repeatedly as a reason for overall inflation missing their targets, for instance in the minutes of the June FOMC meeting.

We believe that this acceleration in price declines is not an accident, but rather the result of at least four powerful structural changes in the US wireless business in the last decade:

  • The end of iPhone exclusivity
  • Convergence in network quality
  • The end of two year contracts
  • The rise in unlimited plans

The first two points are particularly powerful, but do not take it from us, take it from Craig Moffett, the star analyst and founding partner of MoffettNathanson, who explained them very clearly in a recent interview with Bloomberg.

Simply put, it used to be that the different wireless providers in the US were not really perfect substitutes for one another. AT&T (T) carried the iPhone exclusively from 2007 to 2010, and Verizon (VZ) long had the well-deserved reputation of having the best network. If you were a die-hard Apple fan, you had to be with AT&T.If you wanted the best network, you had to be with Verizon. The only reason to go with either T-Mobile or Sprint was to get a lower price.And to get that lower price, many customers would have had to accept far inferior service, as network quality at T-Mobile or Sprint used to be far worse than Verizon or AT&T. To many of the industry’s best customers, it was an unacceptable trade-off, almost irrespective of price.

As a result, AT&T and Verizon largely split the industry’s best customers between them. Even though there were technically four national wireless competitors, the effective number of competitors for the best customers was really one or two. This is why we think it is fair to characterize the US wireless market between 2007 and 2010 as an effective duopoly.Ironically, even this rather cozy duopoly structure did not result in an increase in pricing, with the wireless services CPI flat to declining.

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Disclosure: I am / we are long TMUS.

Disclaimer: None of our writings are intended as financial or any other advice.  For financial advice, please consult your own advisors familiar with ...

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