Strong Execution Continued Into Q2 at T-Mobile; Shares Modestly Undervalued

Business Strategy & Outlook

T-Mobile’s strong brand and reputation, coupled with its industry-leading spectrum position, provides it with an opportunity to drive strong revenue and profit growth over the next couple of years. Longer term, a rational competitive landscape will allow the firm and its rivals to deliver stable, if modest, cash flow growth. In the five years leading up to the Sprint acquisition, T-Mobile expanded its postpaid phone customer base nearly 60% while the rest of the industry stagnated. Despite this growth, T-Mobile remained far smaller than AT&T or Verizon, putting it at a scale disadvantage evident in significantly lower profitability than its larger rivals. With the addition of Sprint, though, T-Mobile is larger than AT&T and reasonably close to Verizon. The combination of scale and strong management should serve T-Mobile well. 2022 will be an important year, as the firm shuts down the Sprint networks and fully moves Sprint customers to T-Mobile’s network and systems, but one has little reason to doubt this process will go smoothly, as integration thus far has been impressive.

The T-Mobile network will match up well with that of its rivals over the long term, and it is worthy of a narrow economic moat rating. Importantly, the massive amount of spectrum the firm now controls puts it in a strong position. Its mid band spectrum holdings, which will likely provide the bulk of wireless network capacity well into the future, are massive and largely unused. The firm avoided matching Verizon and AT&T egregious spending in the C-band spectrum auction as a result. Efficiently and effectively deploying this resource, something Sprint failed to do on its own, is now the firm’s primary objective. T-Mobile’s network isn’t perfect. The firm doesn’t own significant fixed-line assets, which will likely be increasingly important as wireless networks become denser. The firm will have access to third-party networks on reasonable terms, but this remains a risk. T-Mobile also leases many of its spectrum licenses and will need to renew leases or purchase licenses outright in the coming years.

Financial Strengths

T-Mobile had done a great job of reducing leverage over the past few years while Sprint had moved in the opposite direction. The merged firm started life with about $64 billion in debt net of cash, equal to about 2.9 times EBITDA, or about 3.5 times adjusted for Sprint’s heavy use of phone leases. Since the merger, T-Mobile has primarily used free cash flow to reduce leverage, but its participation in the C-band spectrum auction, where it spent $9.3 billion, pushed net debt up to $72 billion at the end of the first quarter of 2022. Growth in the business has still allowed net debt to remain at 3.0 times EBITDA. Net leverage also sits at 3.0 times “core-adjusted” EBITDA, which excludes integration costs but also eliminates the accounting benefit from phone lease revenue. T-Mobile management had said it believes it can run the business with leverage in the 3.0-4.0 times range but now targets leverage at a mid-2s multiple of core adjusted EBITDA, a level it believes it can hit by the end of 2022. Management has said it would need to cut leverage below 2.5 times to receive an investment-grade rating from the major agencies but notes that it has been able to borrow at rates only modestly higher than AT&T in recent years. The firm has also received an investment-grade rating on its secured borrowings. One suspect less favorable debt market condition would have a significant impact on T-Mobile’s borrowing costs. Taking leverage down to around 2.5 times adjusted core EBITDA seems reasonable but one wouldn’t be opposed if the firm drove leverage lower still given the ups and downs of the wireless industry and the financial capabilities of rivals AT&T and Verizon. Management expects to begin returning capital to shareholders in 2023, saying it could buy back up to $60 billion of its shares through 2025.

Bulls Say

After several years of unprecedented success, T-Mobile has the wind at its back. The firm’s reputation with consumers is as strong as ever, and its network is delivering better service than the other carriers.
The Sprint merger has catapulted T-Mobile near the top of the industry, with ample scale to compete and a spectrum portfolio no other carrier can match. Heavy network investment will bring operating costs savings and a lead in 5G.
Free cash flow, already positive during the Sprint integration, should grow sharply, providing the ability to return capital to shareholders.

Company Description

Deutsche Telekom merged its T-Mobile USA unit with prepaid specialist MetroPCS in 2013, creating T-Mobile US. Following the merger, the firm provided nationwide service in major markets but spottier coverage elsewhere. T-Mobile spent aggressively on low-frequency spectrum, well suited to broad coverage, and has substantially expanded its geographic footprint. This expansion, coupled with aggressive marketing and innovative offerings, produced rapid customer growth. With the Sprint acquisition, the firm’s scale now roughly matches its larger rivals: T-Mobile now serves 71 million postpaid and 21 million prepaid phone customers, equal to around 30% of the U.S. retail wireless market. In addition, the firm provides wholesale service to resellers.

(Source: Morningstar)

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