WASHINGTON/NEW YORK (Reuters) - The Obama administration sued to block AT&T Inc's $39 billion acquisition of wireless rival T-Mobile on concerns it would harm competition, launching its biggest challenge yet to a takeover and dealing the carrier a potentially costly blow.
AT&T, led by Chief Executive Randall Stephenson, plans to fight the government's decision in court, and analysts say it might have to make big concessions -- including selling major assets -- to mollify regulators.
Shares of AT&T, the No. 2 U.S. carrier behind Verizon Wireless, fell as much as 5.4 percent. If AT&T's purchase of the No. 4 carrier T-Mobile USA falls through, it may have to pay a huge break-up fee and benefits, such as spectrum grants, worth an estimated $6 billion to Deutsche Telekom.
The Justice Department in a lawsuit filed on Wednesday said eliminating T-Mobile as a competitor would be disastrous for consumers and raise prices, particularly because the smaller provider is considered a pioneer in low-cost service plans.
"The biggest surprise is the timing. Many expected, because of how big the merger (is), the complexities, how big the stakes were, that it would take longer," said Medley Global Advisors analyst Jeffrey Silva.
The lawsuit is a serious attempt to halt a "fundamentally flawed" deal, not a tactic to wring outsized concessions from AT&T, a source familiar with the lawsuit said, adding that the companies would have to give up "so much" to win approval.
"Were the merger to proceed, there would only be three providers with 90 percent of the market, and competition among the remaining competitors on all dimensions, including price, quality and innovation, would be diminished," said Deputy Attorney General James Cole.
The department said it remains open to negotiations with the company, but most likely it will be up to the courts.
AT&T's Stephenson has argued that his company needs T-Mobile to get more wireless airwaves to meet growing demand for high-speed services.
The planned acquisition is a career-defining move for Stephenson, who has lived under the shadow of predecessor Ed Whitacre, said a source close to AT&T. Stephenson put himself on the line with this deal so he has no choice but to double down, the source said.
The government's lawsuit caught AT&T and Wall Street by surprise, coming hours after the telecoms carrier said it would bring back 5,000 call center jobs to the United States if the deal closed.
If the Justice Department succeeds, it would be a black eye for not just Stephenson, but also T-Mobile USA CEO Philipp Humm. Shares of Deutsche Telekom fell 7.6 percent.
AT&T representatives met with Justice Department officials as recently as Tuesday, and received no indication that the lawsuit was coming, a second source with knowledge of the meetings told Reuters.
Another source close to the deal said the two sides were just beginning the back and forth in the review and no detailed discussions about remedies occurred, nor were specific concessions on the table.
"Clearly AT&T didn't expect this," said Pacific Crest Securities analyst Steve Clement. "It changes things for them with respect to the spectrum flexibility they'd have."
The lawsuit is the biggest challenge to a takeover by the Obama administration, which includes former AT&T executive William Daley, who serves as White House chief of staff.
The agency has been working for months on the deal, despite the departure of the antitrust division's chief, Christine Varney. She left for private practice and was replaced by her chief of staff Sharis Pozen on an acting basis.
The federal government has challenged past deals, some of which were abandoned, but on other occasions the companies have fought and been able to close the transactions. The Obama administration has cleared other big deals like Comcast Corp's purchase of NBC Universal.
It remains unclear how the federal courts would treat the case, but one thing most experts agree on is that it would take a long time to wind its way through the system.
The question is whether the companies are willing to pursue that route and for how long, or go their separate ways.
"We plan to ask for an expedited hearing so the enormous benefits of this merger can be fully reviewed," said AT&T General Counsel Wayne Watts.
The $3 billion break-up fee would be the largest-ever triggered, according to Thomson Reuters data. Seven investment banks could also face forfeiting almost $150 million in fees.
"This is an administration that came in saying it was going to have a more aggressive approach," said Michael Sohn, an antitrust attorney with Davis Polk Wardwell LLP.
Another complicating factor is the deal also needs approve by the Federal Communications Commission, which regulates wireless communications. FCC Chairman Julius Genachowski said he is concerned about the deal's impact on competition.
"Ultimately, post concessions, we still expect the deal to be cleared -- eventually," said Liberium Capital analyst Mark James.
A scuppered acquisition could prompt Sprint Nextel Corp, the smallest of the top three U.S. carriers, to consider buying T-Mobile USA, a unit of Deutsche Telekom AG, analysts said.
More immediately, the decision is a letdown for the German carrier and puts a cloud over the senior executives there and at AT&T who exuded confidence about the deal and touted plans to reach underserved areas.
"(Deutsche Telekom) will gain some short-term consolation from the penalties it can exact from AT&T," said John Delaney, an analyst at technology research firm IDC. "But in the end, DT would still be stuck with the problem of how to turn around a sub-scale national operator with a declining subscriber base."
AT&T shares fell $1.36, or more than 4.6 percent, to $28.26. Stock in rival Sprint, which called the lawsuit a "victory for consumers," rose 6 percent to $3.76.
Despite a spike in its shares, some analysts say the picture is not all good because the removal of T-Mobile -- which has a reputation for aggressively under-cutting rivals on price -- could have helped Sprint in certain market segments.
"It's mixed for Sprint. On the one hand, they were potentially going to lose T-Mobile USA as a competitor at the low end of the market," Clement said. "Now it's going to face a T-Mobile that's in a better position prior to the merger proposal, with extra cash and spectrum and a new roaming agreement with AT&T."
The case is USA v. AT&T Inc et al, No. 11-cv-1560 in U.S. District Court for the District of Columbia.
Additional reporting by Diane Bartz and Jasmin Melvin in Washington, Nadia Damouni in New York, Georgina Prodhan and Victoria Howley in London and Nicola Leske in Berlin. Writing by Edwin Chan. Editing by Robert MacMillan