CORRECTED - UPDATE 3-U.S. moves to block AT&T, T-Mobile deal

Wed Aug 31, 2011 2:26pm EDT

* Acquisition would drive up prices, hurt competition -DOJ

* AT&T has said deal is needed to build capacity

* FCC says has made no similar decision

* AT&T shares down more than 4 percent (Corrects 11th paragraph to show that Daley is chief of staff instead of commerce secretary, eighth paragraph to show Sprint might consider buying T-Mobile, not Deutsche)

By Jeremy Pelofsky and Sinead Carew

WASHINGTON/NEW YORK, Aug 31 (Reuters) - The U.S. government sued to block AT&T's (T.N) $39 billion deal to buy T-Mobile USA because of anti-competition concerns, launching the biggest challenge to a takeover by the Obama administration.

A failed deal would be expensive for AT&T, which plans to fight the government's decision in court. It promised to pay a breakup fee worth an estimated $6 billion, including $3 billion in cash, spectrum and a roaming agreement for T-Mobile USA.

The Justice Department, in a lawsuit filed on Wednesday, said eliminating T-Mobile as a competitor would be disastrous for consumers and would raise prices, particularly because the smaller provider offers low prices.

"Unless this merger is blocked, competition and innovation will be reduced, and consumers will suffer," said Sharis Pozen, acting head of the Justice Department's antitrust division.

AT&T will fight the decision in court, said company lawyer Wayne Watts, who added that the Justice Department had given the company no indication that it was contemplating such a move.

The company has argued the deal would let it add capacity and meet demand for high-speed wireless service.

"Clearly AT&T didn't expect this," said Pacific Crest Securities analyst Steve Clement. "It changes things for them with respect to the spectrum flexibility they'd have. They're going to have to be in the market to buy incremental spectrum."

The deal falling through might prompt Sprint Nextel Corp (S.N), the smallest of the top three U.S. carriers, to consider buying T-Mobile, a unit of Germany's Deutsche Telekom AG (DTEGn.DE), he added.

AT&T shares fell $1.26, or more than 4 percent, to $28.35. Stock in rival Sprint rose 9 percent to $3.85.

BIGGEST CHALLENGE

The deal also would need the approval of the Federal Communications Commission, which regulates wireless telecommunications. On Wednesday, FCC Chairman Julius Genachowski said he is concerned about the deal's impact on competition.

The lawsuit is the biggest challenge to a takeover by the Obama administration, which includes former AT&T executive William Daley as White House chief of staff.

"It's mixed for Sprint. On the one hand, they were potentially going to lose T-Mobile USA as a competitor at the low end of the market," Clement said. "Now it's going to face a T-Mobile that's in a better position prior to the merger proposal, with extra cash and spectrum and a new roaming agreement with AT&T." (Additional reporting by Diane Bartz in Washington and Nadia Damouni in New York. Writing by Edwin Chan. Editing by Robert MacMillan)

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