Whither T-Mobile USA?

The Obama Justice Department filed suit Thursday to block AT&T’s proposed acquisition of T-Mobile USA. The case against the merger is compelling, but I never thought the administration would make the political decision to block the merger.

Perhaps the Justice officials bought into a slippery slope argument: if they don’t say “no” to AT&T buying T-Mobile, how could they say no to Verizon buying Sprint. Or maybe it was the strong signs of opposition from the Democrat majority in the Senate.

Even the Wall Street Journal reported that Ma Bell’s efforts to build political support never solved the legal condurum:

If breadth of backers was the main criteria, AT&T's $39 billion purchase of T-Mobile USA would have sailed through regulatory review. … But good corporate citizenry and lobbying expertise aren't the only criteria. And as the Justice Department's court challenge to the deal Wednesday demonstrated, the deal was always long on hype for how it would help consumers, and short on robust legal arguments.
…
AT&T's problem is that the legal issues aren't on its side. Antitrust lawyers had said in recent days that the company's chances of winning approval rested on political issues trumping legal concerns. The fact that the government challenged—months earlier than observers had expected—demonstrates that the legal issues won the day.

On the most basic level, it was evident before the filing, the combination exceeds concentration of market share levels—as defined by the Herfindahl-Hirschman index—that the federal government generally finds acceptable. Divestitures could resolve the concentration risk, of course. But AT&T will find it harder to get around the reality that a merger would reduce the number of national wireless firms from four to three—in the process eliminating a low-priced competitor.

Given that reality, it’s hard to understand why AT&T claimed to be surprised. Shareholders should demand an immediate investigation as to what Kool-Aid® they’ve been passing out at Whitacre Tower, headquarters for SBC AT&T in San Antonio.

AT&T may fight for half a loaf, but any partial AT&T victory would leave T-Mobile in even weaker shape that when the deal was announced — except for the temporary salve of the $3 billion breakup fee.

The problem is, T-Mobile USA (misleading ads with spokesbabe notwithstanding) has no 4G strategy and has been under-investing in the business as an endgame strategy. It’s too expensive to compete with Metro PCS (or Sprint’s Virgin Mobile) and lacks the phones or service quality to compete with the big three.

Of course, if #2 AT&T can’t buy #4 T-Mobile then #1 Verizon certainly can’t. That leaves #3 Sprint, or perhaps some foreign entrant.

Some may claim that this will force a Sprint-T-Mobile merger, but it’s hard to see how. The two have incompatible technologies, and buying the Nextel incompatible technology almost killed Sprint. Also, Sprint’s market cap today is about $11 billion so there’s no scenario where they could approach AT&T’s $39 billion offer or even the $20-25 billion that analysts estimated last Christmas.

My best guess: T-Mobile AG will run the property further into the ground, with no 4G strategy and its advertising-driven price war. Then in a few years, the world’s richest man (not Mr. Bill) will buy T-Mobile USA for less than half of the $39 billion, and integrate it with América Móvil, Latin America’s most successful mobile phone business. It could put together special roaming agreements for the millions who live and call on both sides of the 30th parallel.

Meanwhile, T-Mobile USA won’t have the spectrum or money to build a 4G network, so someday it will have to rent time on a virtual 4G network, whether Sprint’s partner Clearwire or Leap’s Lightsquared.

I’m (temporarily) a T-Mobile subscriber. I suspect the prices will remain attractive as long as T-Mobile is fighting to preserve its subscriber base and prop up the eventual sale price. I’m curious to see whether T-Mobile will start any price wars, or will remain reactive to MetroPCS and Virgin price wars, but in the end I don’t think it will have any bearing on its survival.

Regulated duopoly vs. real competition

Last week, a Senate subcommittee held a hearing entitled “The AT&T/T-Mobile Merger: Is Humpty Dumpty Being Put Back Together Again?” The CEOs of three of the four major cellular companies got a chance to present their positions in between political grandstanding.

I was fortunate to catch the replay Sunday on C-SPAN (one of the few channels my monopolist cable company still provides on basic cable.) A low resolution version of the 2½ hour hearing is also available on the Senate website.

The expert (if self-interested) testimony confirmed what I already knew. As with any consolidation of four major firms down to three, the merger is about reducing rivalry, supplier power and buyer power — good for the surviving companies, bad for suppliers, customers and the smaller rivals.

The Case Against the Merger

The most enlightening testimony came from Victor Meena, CEO of small rural carrier (Cellular South) that (according to Wikipedia) is the 8th largest in the US (after Verizon, AT&T, Sprint, T-Mobile, MetroPCS, US Cellular and Cricket/Leap).

As someone who has spent 15 years studying the history of the US cellular industry — from the prehistory of the 60s and 70s to the boom era of the 90s — I believe Meena has it exactly right. Reducing competition back to a duopoly will bring us back to duopoly-style pricing and duoopoly-style non-competition.

Meena described the merger as a major step backwards for the industry and its customers:

When I began in this business in the late-1980s, there was a local duopoly in every market.… Carriers had virtually no market incentive to innovate or improve service offerings.… In a duopoly, the market can quickly reach equilibrium and, if both providers are reasonably happy with their position, innovation stagnates and prices rise.

The industry changed for the better in the late 1990s, when the FCC, pursuant to Congressional mandate, auctioned off PCS licenses and a substantial number of competitive carriers entered markets—launching a new, healthy competitive era of wireless in the U.S.
…
But this all began to change in the middle of the last decade. Through unfettered mergers and acquisitions, it has become clear that our industry is on a glide path toward Ma Bell reconstituting herself into the 2 Bell Sisters of the wireless industry: AT&T Wireless and Verizon Wireless.
…
Not surprisingly, this concentration of market power has led to less choice for consumers and the routine abuse of market power in an effort to prevent competition at every turn. Specifically, AT&T has used its enormous acquired scale to

1. restrict competitive carrier and consumer access to devices,
2. withhold roaming agreements, and
3. leverage its control over device and infrastructure vendors to Balkanize new spectrum and slow the deployment of 4G LTE technology in the U.S.

Meena and Sprint CEO Dan Hesse identified two other negative impacts of increased market power. As chairman of the CTIA, Hesse has been attempting to negotiate lower rates for wireline backhaul for cellular base stations — rates that AT&T and Verizon want to be high but the rest of the industry want to be low. And by consolidating carriers, Meena notes there will be fewer options for smaller carriers to find roaming agreements for 3G and 4G data, as mandated by the FCC last month.

Supporting Cast

As expected, AT&T CEO Randall Stephenson said little to convince me that the merger is good for anyone other than AT&T, while T-Mobile USA CEO Philipp Humm seemed intent on deferring to his new boss. Verizon’s CEO was strangely absent, either to avoid making arguments that would haunt him when he wants to buy Sprint, or to avoid reminding people that two companies will control 80% of the market if the merger goes through.

Among the leftist activists, the self-appointed “consumer” representative was far more persuasive and honest than the union president. At least she knows what a Herfindahl-Hirschman Index is. Tellingly, she also asked: “have you ever seen AT&T advertise against Metro PCS or Cricket?”

The quality of dialog from the top of the dais was also mixed. The two ranking members of the subcommittee — Sen. Kohl and Sen. Lee — asked intelligent questions that attempted to draw out the witnesses. Two other senators (Franken and Grassley) were dim bulbs acting like a prosecutor and defense attorney for the accused. (Sens. Klobuchar and Cornyn were only slightly better — but at least viewers were spared Chuckie Shumer).

If Not Competition, then What?

Meena offered a stark (and I believe accurate) contrast between the two paths forward:

The prospect of this transaction brings us to a critical decision point for policy-makers: are we are going to continue down the path toward an era of nationwide duopoly, or are we going to lay the foundation for a second competitive era in wireless. There is no third option – either AT&T will be allowed to acquire T-Mobile (paving the way for Verizon to acquire Sprint and cementing a national wireless duopoly); or it will not.

If AT&T’s takeover of T-Mobile is approved, all that will remain is the endgame, where the remaining non-Bell carriers wait their turn to be acquired or bled dry by the biggest two carriers.

And, Meena notes, the likely consequence of returning to duopoly is returning to FCC micromanagement:

[I]f the takeover goes forward, policymakers must begin preparations to regulate every aspect of the day-to-day business of the duopolists. Without effective competition as a check on market abuses, the government will have to interject itself to ensure that consumers – the true owners of wireless spectrum – are protected. This means subjecting a future wireless communications duopoly to the same type of regulatory oversight that wireline telephone and electrical power utilities have operated under for decades.

This idea was echoed by Sen. Klobuchar, who suggested that a more concentrated US market — like the rest of the world — would be a more tightly regulated market.

Of course we know that government (or any central command-and-control bureaucracy) usually does a bad job of assuring either innovation or efficiency. So if the choice for consumers — and app developers and handset makers and website owners — is real competition or regulated duopolists, the best option is obvious.

Saving T-Mobile

If the merger is killed, it still leaves the question of maintaining T-Mobile as an effective competitor. It will take more than just a cute spokesmodel and dishonest branding to have it maintain its market share.

In particular, both Stephenson and Humm pointed to T-Mobile’s looming quandary in the 4G era, given that it hasn’t bought new spectrum in the recent auctions. Actually, the solution for the #4 carrier is relatively simple: do what the #3 and #7 carriers are doing for a 4G network: rent one.

Clearly T-Mobile is not going to join Sprint using Clearwire’s WiMax network, but if Clearwire switches to LTE, it would be an attractive option.

If not, it can follow the lead of Leap Wireless (dba Cricket) in renting the LightSquared network. It’s LTE, it promises to be nationwide, and the T-Mobile/Cricket customer base would be enough to make an attractive business (at least until MetroPCS buys Leap).

Field of 4G Dreams

I’m not at CTIA nor have I been unable to keep up with the flurry of coverage. However, an article by Mike Freeman of the San Diego Union-Tribune caught my eye — not the least because of the skeptical tone by the news bible of Qualcomm’s home town.

Freeman refers to 4G as “the next big thing,” fixation nicely captured by the Gartner Hype Cycle or the earlier 1999 Michael Lewis dot-com chronicle The New New Thing.

Freeman quotes a number of skeptical analysts who (like me) don’t think mobile phone subscribers will increase their monthly bills (i.e. ARPU) for these new networks. Two wonderful snippets:

There’s almost a “Field of Dreams” quality behind the effort — “If you build it, they will come” — with the mantra that additional bandwidth will lead to new applications and services that will justify the investment.

and:

“What is the killer app for this stuff?” asked Michael King, an analyst with technology research firm Gartner. “Why do I need 10 megabits per second to my handset? I’m not going to pay you a heck of a lot more for streaming video.”

The business model, he said, is “to be determined.”

He also quotes Qualcomm VP William Davidson predicting the long transition period during which 3G and 4G will co-exist:

“I think I’ll be retired and we’ll still have 3G in the networks in the U.S. because the economics of covering this vast geography with a technology that is really no more efficient. … I just don’t see it happening.”

So as a useful palliative to the usual 4G hype, it’s recommended reading.

Bye bye Nortel

Once North America’s 2nd largest telecom equipment maker, Ontario-based Nortel Networks Corp. filed for bankruptcy this morning. The expectation is that the company will be sold off in pieces to the highest bidder.

Apparently the proximate cause was a (US) $107m interest payment due tomorrow. Another factor was today’s expiration of a 30-day waiver granted by Export Development Canada on a (US) $750m line of credit — a waiver necessary to use the line of credit after Moody’s downgraded Nortel debt to junk bond status. In its bankruptcy filing, Nortel reported that it owes $187m on that line of credit.

While all B2B firms are facing cutbacks on capital goods orders, Nortel had a particularly bad 2008. Its shares fell more than 95% in 2008 and it was facing delisting on the NYSE. Its September plan to sell off the two units with the highest potential growth — Metro Ethernet and its 4G (LTE) operations — were said to have rattled buyers worried about the longterm viability of the associated product lines.

My guess is that buyers of multimillion dollar infrastructure were spooked because they can read the papers: Nortel has lost nearly $7 billion in the three years that Mike Zafirovski has been CEO. Nortel’s 2006 decision to sell its W-CDMA base station operations to Alcatel was also not a sign of strength for a company that claims to be serious about LTE, the 4G successor to W-CDMA.

In happier times, I would expect that Motorola would be interested in Nortel’s operations, but this is also looming as a bad week for Motorola as well.. Zafirovski is former COO and President at Motorola, and so would know many of the key players there. Motorola’s 4G wireless base station operations are too small for it to make the top ranks of LTE vendors. Motorola and Nortel had a brief (CDMA) infrastructure joint venture in the early 1990s, and back in 2002 there was speculation about some form of combination.

One thing is clear: the death of the 113-year-old former Western Electric subsidiary will be a major blow to Canadian national pride. The company has consistently been the country’s largest R&D spender — still 6x as big as Research in Motion — although increasingly that R&D has been sent offshore to China and other foreign subsidiaries.

Week in review

This week I’ve been swamped coaching my two simulation teams in the final rounds of their International Collegiate Business Strategy Competition. A long slog that began on Jan. 7 (during winter vacation) ended Saturday with both teams victorious.

However, I wanted to comment quickly on a few items:

• The WSJ had a great article (available free) on how Vizio used offshore manufacturing to come from nowhere to be one of the top TV makers — in a virtual three-way tie (with Sony and Samsung) for the most LCD sales in North America. Consumer electronics has been a brutal commodity business with entrenched competitors and (except for flat panels) excess capacity, so Vizio’s success (using open innovation) should be an inspiration for upstarts everywhere.
• Red Hat has beat a retreat from the desktop Linux business. Which Windows advantage matter most — the one from network effects or switching costs? (The exact question I tried to answer with my dissertation). I don’t know, but If Red Hat can’t make it, it’s hard to see how Linux is going to be a major factor in consumer or business PCs — at least in countries with high existing PC penetration rates.
• Adobe’s new Photoshop Express website got a very nice writeup in the WSJ — which basically said it’s about as good as the 1.0 of an online photo program can be. This shows that not only is Adobe trying to remake itself into a SAAS company, but its skills are transferrable. Also that by requiring Flash, its can continue to use its position in one software segment to boost another.
• Some (but not all) of the 4G wireless equipment makers agreed to a patent cooperating agreement to speed adoption of the GSM/W-CDMA derived LTE technology. It’s not clear if the parties have agreed to a formal pool or a set of rules — either for valuing patents or (as announced in August) for deciding which patents are essential. Given the past failure of telecom patent cooperation, this seems more like a promise to agree rather than an ironclad agreement.
• The patent “reform” bill S.1145 seems to be dying, with those big IT companies that want to weaken patents (e.g. Apple, Cisco) unable to overcome the opposition of those that like them just as they are. I wonder if anyone in D.C. understands “win-win” — such as recent efforts to make patent examination more rigorous and accurate.

End to the Wi-Fi mirage

Earthlink is now trying to sell or close its municipal Wi-Fi operations — perhaps because it lost $80 million on municipal Wi-Fi last year (versus $20 million in 2006). Apparently some of the failed services are getting turned off. Earthlink also pulled back from the ill-fated Helio MVNO venture with SK Telecom.

This is probably the beginning of the end of attempts to build self-supporting municipal Wi-Fi systems (as opposed to those subsidized like parks and libraries as a “public good”).

The cause is not that different than Ricochet’s failure in the 1990s. Yes, Ricochet had slow nonstandard modems while Wi-Fi is ubiquitous and cheap. However, the economics of building infrastructure coverage are the same, and today the desirability and adoption of substitutes (other access methods) are probably worse.

Most seriously of all, it seems like the era of paid Wi-Fi is heading towards extinction — because free Wi-Fi at restaurants and coffee shops is becoming more the norm. I had lunch in Mountain View on Sunday and it seemed every bar on Murphy Street had free Wi-Fi. Starbucks announced Monday that it’s offering (limited) free Wi-Fi — to match all the other free sites — further fueling the commoditization of Wi-Fi hotspots. About the only place that people will pay for Wi-Fi is in an airport, because you can’t easily go down the street to find a better alternatives.

Without crunching the numbers, my intuition is that WiMax is going to face the same problem. Yes, the radios have longer range, but you still have to build more cells (and negotiate access and install backhaul) for lots of cells. If WiMax fails, then Sprint's 4G strategy will fail with it.