AT&T: Is T-Mobile a Winner or Loser for Shareholders?

Even before AT&T’s T-Mobile offer, I was a shareholder of AT&T (NYSE:T).  Granted, this company is hardly the growth story most would like to see, but as far as a safe pick for a diversified portfolio its an easy sell.
For one, the landline business, while by no means growing, is still a cash cow.  The infrastructure is in place and the only real cost is to maintain it.  Otherwise, it just brings in cash.  This is important because the growing part of AT&T, its wireless business, cable offerings, and its 4G roll-out, will require substantial capital expenditures to continue to compete for business.

Since the T-Mobile announcement AT&T (NYSE:T) stock has climbed about 10% or so.  Clearly, Wall Street likes the acquisition.  But other than increasing market share, what are the long-term benefits of buying T-Mobile for AT&T and is there more value to be realized here?

Recently, Holman Jenkins, a Wall Street Journal editorialist, expounded on the underlying premise behind the T-Mobile acquisition.  Rather than go through the regulatory hurdles associated with leasing unused broadband spectrum capacity from one of the cable companies, AT&T is betting that the easier route is to buy that spectrum by acquiring a competitor like T-Mobile. 

Even before the T-Mobile acquisition there was a lot to like about AT&T (NYSE:T). They had a strong balance sheet, a growing wireless business, and a brand name that by itself is probably worth tens of billions of dollars.  They also pay a hefty dividend of over 5% which makes the stock even more appealing to those seeking cash flow from their investments.  I had a valuation of around $32.50 per share before the T-Mobile acquisition based on sub-par growth of 2.1% per annum.  That was still almost a 20% premium to what I had bought the shares at.  Its amazing how far pure cash flow and retained earnings can take a valuation! 

The acquisition is composed of $25 billion in cash and $14 billion in AT&T (NYSE:T) stock.  The claim by AT&T is that synergies alone will justify the purchase.  While I doubt that, I do believe that combined with T-Mobile’s existing profitability what synergies there will be will add gravy to the proverbial turkey that is this acquisition.

T-Mobile’s stand alone financials are not available to the extent needed to do a proper valuation.   But just making some conservative assumptions based on what we do know can still give us a decent idea as to whether this is a worthwhile acquisition.

According to the T-Mobile Deal Factsheet “Price represents multiple of ~7x 2010 EBITDA, approximately 5x on a synergy adjusted basis”.  If either are true then T-Mobile would be an absolutely fantastic and value creating acquisition.  If we make certain assumptions about the cost structure of the resulting company, we can estimate what the expected earnings of the combined entity would be.  I am using Metro PCS (NYSE:PCS) to estimate what T-Mobile’s expected depreciation and amortization would be because like T-Mobile its primary business is wireless phones whereas using a proxy like AT&T or Verizon (NYSE:VZ) exposes us to their other businesses like cable and their landline businesses.  I am also assuming a tax rate of 40%.  Making those two assumptions the incremental net income of the acquisition is around $3.3 billion after-tax.  Based on the current price of the shares and the terms of the deal I’d estimate the value of AT&T at around $42 per share which is a hefty jump from my previous valuation of $32.50.

Now obviously some skepticism is in order given that I’m using AT&T’s disclosures on the synergies of the deal, but on the other hand their assumptions don’t seem so unrealistic as to be worthless.  Put simply, I owned it before the deal and I’ll own it after.

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