SNAP ANALYSIS: D.Telekom must make U.S. move or take back seat

FRANKFURT (Reuters) - Deutsche Telekom will have to make an expensive acquisition if it wants to sustain its role in the cut-throat U.S. market -- even if that means cutting its dividend.

“Deutsche Telekom will have to decide to stay in the U.S. and grow at the cost of its dividend or to continue to give value but quit the U.S.,” said Michael Kovacocy, a senior analyst at research group Metacommunicare.

Speculation has swirled about a takeover of U.S. rival Sprint Nextel -- valued at $11 billion -- by the German incumbent ever since the U.S. company announced a huge goodwill writeoff in February last year.

Deutsche Telekom, which will not comment on Sprint rumors, has vowed to keep an attractive dividend policy for shareholders including the German government, which owns around 30 percent of the company, and private equity firm Blackstone with just under 5 percent.

For the past two years its has paid out 0.78 euros per share. Its dividend yield is at 8.2 percent compared with France Telecom at 7.7 percent, Telefonica at 6.3 percent and Vodafone at 5.6 percent, according to Reuters Estimates.

“There is a strong commitment to key shareholders looking to extract value, but not enough growth at group level to continue high remuneration,” Kovacocy said. “There is no real growth strategy, the emphasis currently is on extraction of value.”

That may be changing.


Last week, Deutsche Telekom announced it planned to merge its struggling UK wireless business with France Telecom’s Orange unit. Now all eyes are on the United States, where T-Mobile USA is battling similar problems.

“Sprint is a story that needs to be closely monitored as Deutsche Telekom’s management, in our view, has gained ‘dealmaking momentum’ from its transaction in the UK and it might be tempted to address the ‘other major issue’ it has,” UniCredit’s Thomas Friedrich said.

As in the British market, T-Mobile USA is the fourth player in a maturing industry of five large operators. It is underrepresented in the high-end corporate business.

It would have to beef up spending considerably to catch up with U.S. market leaders Verizon and AT&T.

Currency effects hit company earnings, forcing Deutsche Telekom to issue a profit warning in April.

Chief Executive Rene Obermann, who took over in November 2006, has promised to “fix, focus and grow” the company. He has reduced costs and staff, improved customer service and sold non-core assets.

But unlike charismatic former chief executive Ron Sommer, Obermann may not be bold enough for a major acquisition such as Sprint.

He has preferred instead to acquire stakes in familiar markets such as the Netherlands or Greece or opting for a small buy such as U.S.-based wireless outfit SunCom.

It was under Sommer that Deutsche Telekom bought Voicestream, an acquisition much criticized at the time for being too expensive but that later turned out to be a clever move.


Now, Deutsche Telekom may need to take another bold decision.

Sprint stock was at its lowest in November, when it hit $1.38. On Monday morning it rose 11 percent to $4.18.

“A move to buy out Sprint Nextel would remove a major threat to T-Mobile US’s customer base - (Sprint’s) Boost Mobile,” Kovacocy said, but added: “Such a large transaction would carry significant risks, both financial and executional.”

Sprint had $19.6 billion in long-term debt at the end of the second quarter and its network technology is not compatible with the technology of T-Mobile USA.

“Sprint currently trades at 4.2 times estimated 2010 EBITDA. We believe if Sprint were to be acquired, the board would require a premium valuation in the neighborhood of 5x 2010E EBITDA, which would equate to roughly $5.50/share,” Michael Nelson at Soleil/Nelson Alpha Research said .

“On the surface, we believe a Sprint/T-Mobile combination makes strategic sense as both companies have been losing market share and a merger would remove a competitor,” he said, but warned the two networks posed “significant integration risk.”

There also may stumbling blocks connected to national pride.

An acquisition of Sprint would need support from the German government, which may be reluctant to see Deutsche Telekom shift its attention to the United States from its home market.

“When Deutsche Telekom acquired Voicestream (now T-Mobile USA) in the 1990s the German chancellor (Gerhard Schroeder) had to support the deal and soften U.S. concerns about M&A from a company with a large government stake,” UniCredit’s Friedrich said.

Deutsche Telekom could also opt for organic growth but that would put some pressure on its dividend as well.

“They are between a rock and a hard organic growth path would mean they have to increase capex and that would also put pressure on the dividend,” said Kovacocy.

Editing by Sitaraman Shankar