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Deutsche Telekom's Wireless Wager


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Deutsche Telekom's Wireless Wager

Why it's paying top dollar for tiny VoiceStream

Measured against the nation's wireless giants, VoiceStream Wireless Corp. has been a bit of a pipsqueak. With 2.2 million subscribers, it's about a third of Sprint PCS's size and one-tenth the global heft of Verizon Communications. Its $1.05 billion in revenue is chump change compared with the revenues for AT&T Wireless.

So why would Germany's Deutsche Telekom pay an eye-popping $21,639 per subscriber for the little Bellevue, (Wash.) cell phone company? DT CEO Ron Sommer concedes that he paid retail when he agreed to buy VoiceStream on July 24 for $175 a share, or roughly $45 billion plus cash and assumption of debt. But he insists, over the scoffing of some in the telecom community, that the price "is a fair one."UNSETTLED FRONTIER. Simply put, Deutsche Telekom is not buying subscribers in the U.S. It's buying potential--in this case, the potential to become a dominant player--not just in the U.S., but globally. Partially, Sommer's plan involves the old-fashioned gobbling up of market share. When it comes to cellular service, the U.S. today is like the unsettled frontier: International Data Corp. predicts that by the end of 2000, only about 32.5% of the U.S. population will be using some form of wireless compared with 52% in Europe and 60% in Japan. Growth prospects in such a relatively undeveloped market, the German executives reckon, are so high that their company will emerge almost immediately as a formidable rival.

Ultimately, the deal is part of a massive fight to achieve economies of scale as global telecommunications companies jockey for position in the coming world of wireless Web services. To achieve its heady plans, Deutsche Telekom will run smack up against the nation's giants--Verizon, Sprint, AT&T, Worldcom, and SBC Communications. It also may have to contend with Japan's NTT DoCoMo, which has begun to sniff at potential U.S. telecom and Internet acquisitions and partnerships. Although U.S. telecom execs publicly have feigned indifference, privately some concede that the threat is real. They say a DT-VoiceStream link will force U.S. players to step up efforts to provide wireless Net service to a broader market, including overseas.

In many ways, the global battle could come down to one of technology. DT already offers a wider array of services to its customers in Europe than its U.S. counterparts offer here. Telecom technology execs acknowledge that cell phone makers serving the U.S. market will now begin to produce handsets for the European technology standard called Global System for Mobile Communications. GSM is the only technology offered in Europe, but is used by a slim 10% of U.S. customers. And although it has never been considered a cutting-edge technology, the DT deal will suddenly make GSM a much bigger player in the U.S. market. And that will make it a bigger factor in the emerging U.S. debate over the need to set a wireless technology standard.NO GUARANTEES. To gain this kind of sway over the lucrative U.S. market and the global market, Deutsche Telekom felt it was worth significantly besting the $4,390 per subscriber Britain's Vodafone paid for AirTouch in 1999 or the estimated $12,400 that the combined Vodafone-AirTouch paid for Mannesmann earlier this year. That has set off a torrent of criticism that it has wildly overpaid for its position.

Certainly, there are no guarantees that this deal will be consummated--or that it will be a success if it is allowed to go forward. First, Deutsche Telekom has to overcome potential opposition in Congress: Senator Ernest F. Hollings (D-S.C.) recently introduced a bill that would block any foreign company with more than 25% government ownership from acquiring U.S. telecom assets. DT is 58%-owned by the German government.

Hollings' bill has gained important new co-sponsors, including Senate Majority Leader Trent Lott (R-Miss.) and Senate Minority Leader Tom Daschle (D-S.D.). Even so, as it goes to the Senate floor, a fight, possibly led by Senator John McCain (R-Ariz.), could ensue. And if the bill reaches President Clinton's desk, he is expected to veto it.

But there is also some doubt that the merger will pay off, even if it is allowed to proceed, because of the huge premium that DT paid. The whole tenor of discussion is eerily reminiscent of the talk surrounding AT&T's purchase of Tele-Communications Inc. in 1998. Back then, many also suggested that the price was excessive. Yet the deal was hailed for the scope it would give the long-distance carrier. AT&T CEO C. Michael Armstrong reassured investors that taking the costly leap forward to become the dominant player in an evolving telecom market was worth it. But so far, AT&T has yet to see much return from its expenditures, and investors have soured mightily on the stock.

Like Armstrong, Sommer is confident. Here's what he considered when he agreed to the price: VoiceStream owns licenses in 23 of the top 25 U.S. markets. In wireless lingo, its licenses cover areas with a 220 million subscriber base. Though it has relatively few subscribers signed up and currently does not actually provide service to many of the locales where it holds licenses, it is adding subscribers at a sizzling pace--an 18.5% growth rate that is among the top in the industry. "They're not buying a static base of subscribers, they're buying dynamic growth," says Louis P. Friedman, head of media and communications mergers at Donaldson, Lufkin & Jenrette, DT's banker on the deal. Now, with Deutsche Telekom's backing, "There's potential for VoiceStream to leapfrog the competition," says Kevin Roe, a wireless analyst for ABN-AMRO.WAR CHEST. No doubt, wireless companies across the country are taking note, given DT's deep pockets and promise to make a starting investment of at least $5 billion in VoiceStream. Combined with Deutsche Telekom's wireless arm, T-Mobile, the unit would boast nearly 20 million subscribers and a potential subscriber base of a stunning 360 million worldwide. That would dwarf every U.S. carrier except Verizon. The new company would have nearly $8 billion in revenues and a market capitalization of $150 billion-plus, not to mention access to Deutsche Telekom's war chest of cash. "DT can pump a lot of money into [VoiceStream]," says Jane Snorek, an investment officer at Firstar Investment Research & Management Co., a VoiceStream shareholder. "If you can't buy some market share with that, you shouldn't be running a business."

Closing the gap--and fast--is precisely what managers of VoiceStream and Deutsche Telekom have in mind. With the $5 billion, VoiceStream CEO John W. Stanton can accelerate construction of wireless systems in places like California and Ohio. Stanton estimates that the cash infusion will help him push up the roll-out of his service by 6 to 18 months. Hurdling rivals won't be easy, however. VoiceStream doesn't operate a true national network, and in areas where it does operate, the network is "underbuilt," says analyst Bob Egan of the Gartner Group.

Stanton can also offer DT's European technology for the wireless Web, which is far faster than what's offered in the U.S. Here, too, VoiceStream faces stiff competition from SBC and Sprint, which are spending sizable amounts to launch speedier data systems by yearend.

Even so, the key to DT's plans to grab the lead in the U.S. market involve much more than speed. Primary to gobbling up market share is the acquisition of more spectrum licenses when the Federal Communications Commission holds an auction, tentatively scheduled for the fall. Companies such as Verizon and BellSouth want this spectrum desperately. DT's cash is expected to allow Stanton to participate in a major way in the upcoming auction.

To gain control of market share, VoiceStream also anticipates being able to deliver a variety of nifty services that Deutsche Telekom international operations chief Jeffrey Hedberg says will "delight customers." Foremost might be a kind of uber one-rate--where customers get the same rate no matter where they roam between Seattle and Berlin. DT execs, however, concede that such plans have not yet been addressed.

For now, their attention is focused on getting the deal done. VoiceStream's Stanton and Deutsche Telekom's Hedberg spent much of July 25 pitching their story to skeptical legislators in hopes of making it over the regulatory hurdle. They tried to divert attention away from German ownership by arguing that they will create a new competitive force. Rather than leaving behemoths such as SBC and Bell Atlantic to dominate U.S. markets, they argue, the merger will increase competition. VoiceStream would no longer be a David scrapping with Goliaths. It would become an equal with just as much ability to score a knockout as the other guy.By Roger O. Crockett in Chicago with David Fairlamb in Frankfurt, and Bureau ReportsReturn to top


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