The premise sounds reasonable enough: Combine two companies operating in the same industry and eliminate overlapping expenses. The result is more total profit than the two organizations would be able to achieve between themselves on their own. That's why the recently green-lit merger of telecommunication companies Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) has stoked investor optimism.
Japan's billionaire investor Masayoshi Son is stoked as well. His company, SoftBank (OTC:SFTB.F), will be a partial owner of the new entity, though his 27% stake still won't be quite as big as the 42% that the merged outfit Deutsche Telekom (OTC:DTEG.F) will hold. Both major shareholders believe the combination can compete with wireless industry leaders AT&T (NYSE:T) and Verizon (NYSE:VZ). Sprint and T-Mobile just need more scale to drive even greater profit growth.
History shows that the suggested synergies of the merger aren't guaranteed, though, and there's some data to back the idea up.
Neither Sprint's CEO Marcelo Claure nor T-Mobile's chief John Legere has been hesitant to talk specifics. In early 2018, just a few months after the merger idea was once again broached, official statements from both organizations suggested the pairing could produce $6 billion worth of recurring annual synergies, if not more. For perspective, the two companies collectively drive $78 billion worth of annual revenue.
Perhaps more important, the union of T-Mobile and Sprint could create a mechanism strong enough to pry meaningful U.S. market share away from Verizon and AT&T. The two top names in the business currently control approximately 41% and 29% of the wireless market, respectively, while Sprint holds 12%. T-Mobile's share is on the order of 17%.
Simply melding two smaller names to form one larger one isn't inherently a path to wider profit margins, though.
Yes, the expected synergies were derived using data that's anything but ambiguous. Of the $6 billion figure being batted around, $4 billion of it was connected to network equipment and infrastructure. Another $1 billion of it stems from redundant selling and administrative expenses, while the last $1 billion is linked to back-office costs. Both companies have reasonably good guesses about which operations can be shared and which can't.
Or maybe they don't.
Statistically, the odds are long
The numbers vary somewhat from one study to the next, although they all point in the same general direction: that most mergers and acquisitions don't yield the synergies touted before they take shape.
And the numbers are staggering. A study done by L.E.K. Consulting found that of 2,500 deals done between 1993 and 2010, 60% of them ultimately hurt rather than enhanced shareholder value. Similar research performed by business consultants McKinsey & Company determined that less than 40% of mergers even come within 80% of their suggested revenue synergies, while only about 60% of deals lead to their expected cost savings. KPMG Global says 83% of dealmaking doesn't add to shareholders' total returns.
The data is getting a little dated, but the undertow of overestimated synergies is flowing ever faster. Duff & Phelps suggested early this year the total amount of goodwill impairments -- the way of writing down bad M&A deals -- is expected to grow at a double-digit pace again this year as last year's deals are reevaluated.
We don't have to look very hard to find one of these expensive busts, either. The merger that paired food giants Kraft and Heinz into Kraft Heinz (NASDAQ:KHC) has proven torturous for shareholders. The stock's down more than 60% since the 2015 deal was consummated, with revenue growth never taking shape, let alone earnings growth. General Electric (NYSE:GE) took a $22 billion charge last year, mostly stemming from its 2015 purchase of Alstom that failed to come anywhere close to reaching its expected upside. Kraft Heinz's deal-related goodwill impairment was a smaller $7 billion, though no less painful to shareholders.
To that end, that $6 billion worth of annual savings from the Sprint/T-Mobile merger? Estimates are that it's going to cost about $15 billion up front to make it happen.
This time is different ... unless it's not
Never say never. Some mergers pan out as hoped. Somehow it seems the combination of two organizations that do the exact same thing would readily find easy ways to synergize. Those are assumptions that have been made -- even touted -- by CEOs of merging companies in the past, however, to no avail.
And then there are two overarching challenges to finding those synergies, even beyond the usual ones linked to the tendency to overestimate what costs can be cut.
One of them is difficulty in melding two distinctly different corporate cultures. As Ted Bililies, head of the organization and transformative leadership practice at AlixPartners, recently commented at a CEO roundtable on the matter, "It's never because it was a bad idea around strategy or product. It's almost always around culture, around people." Sprint and T-Mobile have developed remarkably different corporate cultures.
The other potential impasse is that $4 billion worth of network savings was suggested at a point before the 5G race was even in view. Both AT&T and Verizon are better positioned to outspend a newcomer just to make sure they're able to leverage the advent of 5G as a means of keeping the Sprint/T-Mobile entity in a distant third place.
Putting it all together, there are just too many plausible pitfalls and too much risk to expect Sprint and T-Mobile's union to turn into a cost-cutting disruptor.