T-Mobile Needs Sprint Merger To Remain Competitive: Analyst (TMUS)

T-Mobile attracted new customers at a breakneck pace with its “Un-Carrier” initiative, offering to pick up the tab for new customers willing to break contracts with their existing provider. Some 1.3 million monthly subscribers were added in the first quarter of 2013 alone.

But the cost of those early termination fees (ETFs) was steep, bringing the wireless company fresh recruits at a loss of $151 million. Some investors question whether the process is sustainable, but BTIG Research analyst Walter Piecyk says that such losses are necessary for a telecommunications company to grow.

“Telecom is a scale business,” Piecyk told International Business TImes. “You want as much revenue for your fixed costs as possible, so it's very important to grow revenue.”

T-Mobile US Inc. (NYSE:TMUS) saw margins fall to 20 percent from 29 percent in January to March of last year, but its revenue growth – thanks to all the new subscribers – have made it a very attractive prospect as Sprint Corp. (NYSE:S) pursues a merger of the two companies. As it scales up the number of paying customers, profits will fall in the short term.

“T-Mobile returned to revenue growth for the first time in two years,” Piecyk says. “So the growth in subscribers more than offset the decline ... from some of their strategies.”

Similar to how subsidizing mobile phone purchases cost carriers when they signed customers to new contracts (a business model T-Mobile has eliminated in its move to prepaid), telecoms care more about having a paying customer every month.

“At the end of the day, no matter whether it's termination fees or leases, it's still taking the same form of the same thing where you’re subsidizing, paying an upfront cost to get new customers,” Piecyk said, “That is an economic model that has existed in the wireless business for decades.”

While T-Mobile returned to revenue growth for the first time in two years, it is still far behind bigger carriers in customers. Imagine riding on a Segway trying to catch up to sports cars driven by AT&T (NYSE:T) and Verizon (NYSE:VZ) in years past.

“This has been extolled as T-Mobile’s best quarter ever, yet Verizon’s market share of wireless service revenue increased in the first quarter as well,” Piecyk said. “In the best quarter that T-Mobile ever reported, the dominant player was still able to grow their market share.”

T-Mobile is increasing the scale of customers paying their bills every month, but to compete with the “Big Two,” it will need to merge with Sprint. Piecyk said “the combination of Sprint and T-Mobile would provide them with the needed scale to be more competitive.”

Strong subscriber growth may have a temporary impact on T-Mobile’s profits, but the real challenge will be for the carrier to hold onto those customers. “You don't really buy loyalty that way in my view, and those customers will switch back," Verizon CEO Lowell McAdam said during a company webcast at this year’s Consumer Electronics Show, and Piecyk was inclined to agree.

“With the growth of wireless data usage ... it’s going to be increasingly difficult for Sprint and T-Mobile to individually be competitive with companies that can spend more than both of them combined on their network,” Piecyk said.

Verizon lost 138,000 phone customers in the first quarter, but added 539,000 new subscriptions overall thanks to tablets, while AT&T added 621,000. “They'll have plenty of room if they elected to cut prices to take more share back from T-Mobile,” Piecyk said.

To continue to compete, a combined T-Mobile/Sprint would be able to make additional pricing moves to gain customers, or to create more loyal customers. The way to do that, Piecyk said, is by offering a faster network.

“Competition is not always about the lower price, its also about building a better network,” Piecyk said. Since T-Mobile and Sprint pay competitors to access their wireless networks, it increases both companies’ costs. By combining their spectrum and revenues, the two “would have an opportunity to build networks that have faster speeds than existing operators … and the capacity to handle it.”

Combining T-Mobile and Sprint is exactly what Softbank CEO Masayoshi Son plans to do. The Japanese telecom owns the majority of Sprint, but it will have to overcome many regulatory obstacles to do so, including an FCC that credits T-Mobile’s success on its failed merger with AT&T.

If the merger succeeds, then it could have an impact on the troubled wired broadband industry, Piecyk said. With the amount of spectrum and revenue the merger would provide, the new company would be able to offer a product to the same customers who were most willing to cancel their landline telephones when they started paying for mobile: retirees.

“My mom uses an iPad to go online,” Piecyk said. “Her Internet could be more than handled with a 5-gigabyte or so rate plan on LTE. So why is she paying Comcast $50 a month for broadband?”

Follow Reporter Thomas Halleck on Twitter