Deutsche Telekom AG will likely be forced to sweeten the terms of its deal with MetroPCS Communications Inc. after proxy advisory firm ISS recommended shareholders vote against the proposed transaction, according to analysts.
Shares in MetroPCS rose 3.5 percent in New York Thursday after ISS said late on Wednesday that it was backing the efforts of two big MetroPCS shareholders to block the company's proposed merger with T-Mobile USA, Deutsche Telekom's U.S. unit.
ISS complained about the negative market response to the deal, a lower equity split than justified for MetroPCS, and the company's potential to thrive as a stand-alone company.
Paulson & Co, the biggest MetroPCS shareholder, and another big holder, P. Schoenfeld Asset Management, had both committed to vote against the deal on concerns about the valuation and the amount of debt being assigned to the combined company.
Even so, another big shareholder, Madison Dearborn, had put its support behind the deal.
Analysts said the negative recommendation from ISS was a blow against DT's current offer, which shareholders are set to vote on at a special meeting April 12.
"In our view, this is a very significant development as index funds tend to follow ISS's lead," said Jennifer Fritzsche, an analyst at Wells Fargo.
Deutsche Telekom said in response to the ISS report that it still sees the existing merger agreement as beneficial to itself, MetroPCS and both companies' shareholders.
MetroPCS said the ISS report "contains material flaws and reaches the wrong conclusion." It also noted that Egan Jones, a smaller proxy firm, advised its clients to vote for the deal.
Shareholders are still waiting for the recommendation of another proxy advisory firm, Glass Lewis, which is expected to issue a report on the deal this week.
A group of shareholders led by Merger Fund sued the company on Thursday seeking an injunction to halt the planned shareholder vote. It contends that the company did not properly explain the deal so shareholders did not have enough information to vote. They also complained about the deal's valuation.
Representatives for the companies were not immediately available for comment on the lawsuit.
Macquarie analyst Kevin Smithen said Deutsche Telekom might wait until both firms make their recommendations before making any changes. Smithen raised his share price target for MetroPCS to $13.50 from $12 on Thursday as he expects the ISS recommendation to trigger changes to Deutsche Telekom's offer.
Smithen said if Deutsche Telekom reduces the proposed debt level for the new company by a range of $3 billion to $4 billion, it would be enough to win shareholder support.
The biggest gripe MetroPCS shareholders have with the deal is a proposed debt load of $21 billion, according to analysts and investors.
Analyst Jonathan Chaplin of New Street Research said shareholders would likely push for less onerous terms on the debt and for governance changes as well as lower debt levels, before they would vote for the deal.
"We believe the transaction has strong strategic and financial merits; however, we have argued that the terms need to be amended," Chaplin said.
T-Mobile USA, the No. 4 U.S. mobile provider, and its smaller rival MetroPCS want to pool their spectrum resources and networks in order to compete better with bigger rivals such as Verizon Wireless, AT&T Inc and Sprint Nextel .
Under the terms of the reverse-merger announced in October, Deutsche Telekom would end up with a 74 percent stake in the combined company, and MetroPCS would declare a 1-for-2 reverse stock split and pay $1.5 billion in cash to its shareholders.
If the deal collapses it would be a huge blow for Deutsche Telekom, since in 2011 it had to abandon its plan to sell T-Mobile USA to AT&T for $39 billion due to opposition by regulators.
In the roughly nine months it took for that deal to collapse, T-Mobile USA lost many customers, having been distracted from its core business.
On top of these issues, the companies are expected to soon face tougher competition from an emboldened Sprint, which has agreed to sell 70 percent of its shares to Japan's SoftBank Corp for $20 billion.
P. Schoenfeld Asset Management LP, which says it owns about 2.5 percent of MetroPCS, is leading a proxy battle against the deal. Paulson & Co has a 9.9 percent stake, and Madison Dearborn owns about 8.3 percent of MetroPCS shares, according to the most recent public disclosures.
MetroPCS shares had slid more than 8 percent since Oct. 1, the day before reports emerged that MetroPCS and Deutsche Telekom were in talks. The shares were up 37 cents at $10.90 on the New York Stock Exchange after the news.
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