These are the real reasons why Deutsche Telekom wants to combine with T-Mobile
The synergies of the deal alone can save Deutsche Telekom as much as $4.5 billion annually.
Why Deutsche Telekom wants to combine with T-Mobile | Image by PhoneArena
With Deutsche Telekom's stock valued at a Price Earnings (P/E) ratio of 15.62 and T-Mobile's P/E ratio at 19.75, each dollar of T-Mobile's earnings per share figure has a higher valuation than a dollar of Deutsche Telekom's earnings per share number. This gap in valuation is exactly why Deutsche Telekom (DT) wants to create a single holding company that owns both telecommunication companies.
A combined Deutsche Telekom-T-Mobile would be the largest telecom company in the world
A successful coupling of the two telecommunications companies would be the largest M&A deal in history. It would also create the most valuable wireless provider in the world, topping current leader China Mobile, which has an approximate valuation of as much as $231 billion.
DT is the largest telecommunications company in the West with 273 million mobile customers in 50 countries and a majority 54% stake in T-Mobile. Tim Höttges, Deutsche Telekom CEO, is still pushing for a deal that would combine the conservative German firm with T-Mobile, a company that the Wall Street Journal recently characterized as "flashy."
For Deutsche Telekom, merging with T-Mobile is a valuation arbitrage play
To be sure, a deal that creates a single wireless mammoth from two companies with different approaches to the business is not widely backed. Let's explain why pulling off this valuation arbitrage play would be a big deal to DT. Since the new, combined entity would probably trade at T-Mobile's higher P/E multiple, the new company would have a higher valuation.
If pressured to choose, what is DT's top reason for wanting this deal?
But there is more than just that. T-Mobile currently generates two-thirds of DT's revenue, but owning only 54% of the U.S. carrier means that Deutsche Telekom gets only 54% of the cash that T-Mobile throws off. Owning 100% of T-Mobile means that DT would keep 100% of the huge cash flows and dividends that T-Mobile produces.
Deutsche Telekom's shares are well off their all-time high. | Image by Yahoo Financial
T-Mobile would also benefit by being able to raise capital cheaply by using its stock as currency. Right now, this is not an option because issuing additional shares to pay for spectrum or other pieces of the mobile infrastructure would reduce DT's ownership percentage of T-Mobile until it was no longer a majority owner.
The synergies of the deal alone can save Deutsche Telekom as much as $4.5 billion annually
However, if Deutsche Telekom were to own 100% of T-Mobile, the latter could use its shares to make acquisitions without DT worrying about losing its majority holdings in the Un-carrier. And let's not forget the synergies, the back office rewards for combining the two telecom giants. The two firms combined would be able to take a machete and whack away at $3 billion to $4.5 billion in annual intercompany overhead by eliminating redundant corporate costs.
This is more or less a balance sheet trick that unlocks hidden value for DT. With a combined Deutsche Telekom-T-Mobile estimated to have a valuation of around $300 billion, the company would be able to take on more debt and at lower rates, too.
But what about the little guy? T-Mobile investors, who would have to vote on the merger, get little in the way of benefits. In addition, they will be saddled with DT's low-margin businesses. Besides trying to get T-Mobile holders to vote for the merger, Höttges will have to convince the German state, which owns 28% of Deutsche Telekom, to go along with the deal.
After that, the daunting task will remain of getting regulatory approval. It is hard enough to get the green-light from U.S. regulatory agencies for a big deal like this, but this transaction would require approval from the German government as well.
Shares of both companies have been sliding since word of this potential deal first leaked
The shares of both companies have pulled back since talk of a potential merger was first mentioned on April 21.
Since that date, T-Mobile's shares declined from $195.39 to yesterday's close of $185.82, a decline of 4.9%. Over the same period, Deutsche Telekom's shares dropped from $34.04 to $32.67, a 4% decline.
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