So 2004 has started and ended with a major US cellco merger. The difference in style and execution of the two deals symbolizes wider contrasts that will filter through to the market as the four companies involved go through their transition periods. The takeover of AT&T Wireless by Cingular was messy, protracted and the buyer has been saddled with an inflated purchase price and a difficult consolidation process. Though the two companies achieved market leading bulk, their marriage was one of deeply flawed operations with poor customer service records and unimaginative future technology paths.
As such, they were representative of the US communications industry as a whole, and will face all the problems of that sector in trying to turn their ship around. By contrast, the speed and decisiveness with which the (admittedly far simpler) Sprint-Nextel merger has been engineered, and the approach of the participants, throws out hope of a new vigor among the mobile operators. These are two companies that have already gone a long way to turning themselves around and adopting creative strategies to compensate for their relatively small size.
They have huge differences - of technology, culture and customer base - but bring many strengths that a strong management should be able to combine to become more than the sum of their parts. Sprint-Nextel will remain firmly in third place in terms of customer numbers, but it stands a good chance, if recent performance is anything to go by, of being the most profitable, fast growing and creative of the cellcos, and of creating the first national US broadband wireless network into the bargain.
There are many question marks, of course, over how easily they will achieve integration of businesses, networks and brands - and a lurking disappointment that Nextel was not braver, using its street fighting ways to create a fourth generation network in its own right. But cellular services round the world are becoming a business where size is critical and where there is a real advantage to having multiple delivery networks.
Verizon backs off bid
The other big question mark hangs over the cellcos that have not made a merger this year. Verizon Wireless, widely tipped to mount a reactive bid for Sprint (and still favored by some to go after the combined Sprint-Nextel, a deal that would surely attract antitrust authority attention) in the end stayed its hand. This was probably a wise move. Verizon Wireless is storming ahead, and taking aggressive advantage of the disruption within Cingular's customer base caused by the merger.
Its next generation roll-out, based on CDMA EV-DO, is well ahead of other 3G deployments in the US and it even announced its first 3G handset this week. Plus its relegation to second place in the rankings has made it easier for it to snap up small local cellcos and spectrum that has become available recently, including much of the NextWave PCS assets, without attracting regulatory disapproval. This seems a good time for Verizon to expand its spectrum base and take its very real chance of regaining the number one spot organically, without the expense and pain of a hostile acquisition, and while all its rivals are distracted.
T-Mobile is far more problematic. It is now a minnow floating behind three giants and has the least clear growth path of any of the players. Although it has been innovative in building a national Wi-Fi hotspot network that has improved its customer acquisition and loyalty overall, this is small fry considering that it does not expect to be able to launch 3G for two more years. While its parent company is highly committed to a creative multi-network strategy encompassing cellular, Wi-Fi, WiMAX and Flarion, the US arm, for all its successes in building subscriber base and ARPU, lacks the spectrum to have a clear way forward. But is foreign ownership by Deutsche Telekom ties its hands in terms of possible merger opportunities of its own - the German giant, once apparently inclined to sell off its US subsidiary, has recently gone very cold on the idea.
T-Mobile's continuing ability to compete in a 3G world pivots on spectrum. More of that will be becoming available, notably with the planned FCC auction of 1.9GHz bands currently occupied by the government. But this might not be usable for another 18 months, and there will be fierce competition for the precious assets. T-Mobile says it has put $2.64bn aside for acquiring spectrum, but that is unlikely to be enough to build a national network, even with network sharing deals. Verizon already set a marker price of twice that, when it argued - in fighting off Nextel's spectrum swap deal with the FCC - that it would pay more than $5bn for national PCS licenses. And, importantly, T-Mobile lacks the type of management team and lobbying power that enables Verizon and others to get their own way so often with the FCC.
Also, T-Mobile's revenues from current networks are not on the scale to support a massive network upgrade, particularly if its parent is unwilling to take on significant new debt for the move - which would be very unpopular with shareholders.
T-Mobile has been a great success, and a huge prop to its parent during the telco slump, with earnings up fivefold in the past two years. But the new scale of competition and its inability to roll out networks at the speed of its rivals are a real threat to its margins, and that will have a knock-on effect on confidence in Deutsche Telekom stock overall, which remains over dependent on the buzz factor of the US cellco (it has risen in value by 13 per cent this year, primarily on the back of T-Mobile USA's strength.)
T-Mobile argues that its membership of an international group means it gets better equipment pricing deals than its rivals and that the delay in rolling out 3G could prove an advantage, because it will be able to launch services into a market that is ready for them, rather than seeking to create one - an argument it is also using to slow down its 3G pace in Europe. It has grown its subscriber base more rapidly this year than any other cellco apart from Verizon and is highly creative on branding. And it could use its hotspot network to deliver some data services and VoIP.
Yet it has no obvious deal partner of its own, even if its parent were willing. If confidence in the US arm wanes and that starts to affect Deutsche Telekom's value, the German telco might think again about selling off the unit. But its likely partners would lie in the second tier. Vodafone could revisit its option of breaking with the Verizon Wireless joint venture and acquiring T-Mobile to go it alone in the US, but Deutsche Telekom would be hostile to helping one of its biggest challengers in Europe.
Acquisition by Cingular would be barred by antitrust and Verizon and Sprint Nextel have incompatible networks. The remaining chances might lie with a wireline or alternative telco seeking to get into mobility - AT&T, a cable company or, remote chance, Qwest perhaps - or combining with one or more regional cellcos to create a spectrum patchwork rather as Nextel did in the 1990s.
The strengths of Nextel and Sprint
We expect to see a wave of consolidation among tier two cellcos and, possibly, a move away from landlines by many players. Verizon and Sprint have both considered spinning off their landlines and there is a logic that the US market could support a single wireline structure, perhaps controlled by AT&T or even Qwest. As for Sprint and Nextel themselves, their immediate challenges will be to ensure that they make a strength out of their differences, not a conflict. Nextel is famous for its margins and low churn, its popularity with enterprises and its Push to Talk service, until recently its exclusive preserve and one of the linchpins of its high customer loyalty rates. Although devised for its current iDEN network technology - of which it is the only major user - Push to Talk has now been created, in association with Qualcomm, for the EV-DO system that Sprint is using for its 3G build-out.
Sprint, on the other hand, has an increasingly effective consumer brand and a highly successful mobile virtual network operator (MVNO) business, in which it leases capacity to companies such as Virgin Mobile that do not have their own networks. Nextel had, until the eve of the merger, been aggressive in statements that it would not go down the MVNO route and this is just one of many differences of approach and culture that will need to be addressed in the early months of the merger.
Sprint's biggest contribution to the combined group, we believe, is not just its broad spread of spectrum assets in both cellular and 2.5GHz, but its extremely advanced and creative approach to convergence and flexible business models. It has proved itself with the success of its classic MVNO offering, but is now looking to a twenty first century version that is more innovative than anything suggested by Cingular or Verizon. In particular, it has been talking to the cable companies about leasing them national EV-DO and/or WiMAX capacity so that they can achieve their dearly held goal of offering mobility, and Sprint often discusses a single phone that could send calls via a cable modem at home and over PCS outdoors. While such convergence ideas are commonplace among the wireline and multi-network carriers of Europe, they are far more revolutionary in the US, and Sprint is leading the way.
The cultural integration will likely be tougher than that of the equipment, though that has attracted many of the headlines. Motorola will lose out badly, since Nextel is its largest customer and it could have hoped to supply the cellco's next generation network too, if it were based on EV-DO - now, the combined companies will go with Sprint's suppliers, including Lucent. There was even speculation that Motorola would acquire or OEM the Flarion Flash-OFDM gear, had Nextel chosen that, in order to keep its favorite customer. Flarion also loses out then, although the new company could still use Flash-OFDM, instead of WiMAX, when it decides to do something with its MMDS assets.
Unlike the Cingular deal, which was all about size and little to do with creativity, the Sprint-Nextel merger has huge potential to change the face of the US telecoms market. It will almost certainly benefit its participants more than trying to compete independently in a sector that is all about scale. But if the company's advantages in terms of ideas, partnerships, spectrum and management are built upon, it could also create a new breed of US cellco, and one that could stop Verizon from carrying all before it.
Copyright © 2004, Wireless Watch
Wireless Watch is published by Rethink Research, a London-based IT publishing and consulting firm. This weekly newsletter delivers in-depth analysis and market research of mobile and wireless for business. Subscription details are here.