Taking Stock

Despite Failing To Sell T-Mobile U.S., Deutsche Telekom Shares Still in Demand

  • Why it matters

    Why it matters

    A failed merger between T-Mobile US and Sprint has German telecommunications giant Deutsche Telekom reconsidering its options. Both T-Mobile US and parent Deutsche Telekom remain good buys for investors.

  • Facts

    Facts

    • T-Mobile US’s share price dropped sharply after merger negotiations with Sprint failed.
    • The merger failed partly because of the FCC’s opposition to reducing the US mobile communications market from four to three providers.
    • Both Deutsche Telekom and T-Mobile US are doing well financially and stand to benefit from a spinoff.
  • Audio

    Audio

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The first reaction was nothing less than shock. After reports that merger talks with competitor Sprint had broken down, large numbers of investors sold off their shares in the American mobile communications company T-Mobile US in the middle of last week.

Within days the share price had fallen by 10 percent, to below $30 (€22.46), where it has remained. The decline was understandable, since speculation over a takeover had initially pushed up the price of T-Mobile shares, which were trading at about $34 in early August. Deutsche Telekom, which holds about two-thirds of shares in the US company, also lost ground. Its share price had dropped by about 5 percent within a week and has remained under €11 since then.

The turmoil in the markets has now given way to a levelheaded view of events. It is clear that a shakeup in the US mobile communications market is not happening in the medium term because the Federal Communications Commission continues to insist on four providers. A merger of the third and fourth-largest market players, Sprint and T-Mobile US, would have left only three companies standing.

Until recently, it was rumored that Sprint intended to offer up to $40 a share for T-Mobile. Synergy effects were cited as justification for the markup. It is questionable whether another prospective buyer from the US cable industry or US satellite provider Dish will offer a similarly high price. A $15 billion cash offer by French low-cost telecommunications provider Iliad seems to be off the table. It’s too low for Deutsche Telekom CEO Tim Höttges.

The medium-term outlook for investors is good, both for T-Mobile US and the Bonn parent company.

At the company’s headquarters in Bonn, the signs point to a spinoff of the US subsidiary. And why not? T-Mobile US has developed very well recently, and it is attracting new customers in droves with its aggressive marketing. CEO John Legere plans to oust competitor Sprint from the third-place slot by the end of the year. The strategy of increasing revenues by luring customers with special offers, and then hoping for increased profits, seems to be working. Earnings before interest, taxes, depreciation, and amortization, otherwise known as EBITDA, increased to just under $1.5 billion, or 22 percent, in the second quarter. Deutsche Telekom CFO Thomas Dannenfeldt expects profits to continue to improve.

The medium-term outlook for investors is good, both for T-Mobile US and the Bonn parent company, which still benefits from a stable domestic market and its growing share of the mobile communications sector – despite substantial efforts by the competition.

This has led many analysts to stick to their target prices for Deutsche Telekom. Major French bank Societé Générale still recommends buying the stock and expects the share price to increase to €14 within 12 months. The telecommunications company’s revenues are in line with market expectations, say analysts at Societé Générale, while improved trends in Germany and the United States have kept EBITDA above expectations. Independent Research, which describes itself as Germany’s largest independent analyst company, is more conservative, pricing Telekom stock at €13 in the medium term.

In other words, Deutsche Telekom’s US subsidiary will be doing perfectly well on its own, at least for a while. Still, Mr. Höttges is likely to be looking around for new purchase offers. On the one hand, T-Mobile US, even as the number three player, will never have the same financial resources as market leaders Verizon and AT&T. In addition, the US subsidiary faces billions in costs for new frequencies starting in 2015, costs it will hardly manage to stem through cash flow but that will in fact require new borrowing or even help from the German parent.

Besides, Standard & Poor’s expects competitors to counter T-Mobile’s strategy with aggressive price campaigns of their own soon. This is likely to affect profits among all providers, and when that happens things will become unpleasant for Mr. Legere.

Translated by Christopher Sultan

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