- TMUS experienced subscriber growth in the recent past thanks to its “un-carrier” strategy.
- TMUS has posted revenue growth of around 24% this quarter.
- The foray into LTE can be a game changer for the company.
T-Mobile (NYSE:TMUS) is a U.S. wireless communication company. We started our coverage on the company in November, 2013. To review, the company is a subsidiary of Deutsche Telekom (OTCQX: OTCQX:DTEGY) which holds a 67% interest. TMUS experienced subscriber growth in the recent past thanks to its "un-carrier" strategy. The company offered "no contract" plans, frequent device upgrade plans and unlimited data for tablet subscribers which resulted in subscriber growth. The company merged with MetroPCS and also raised financing to expand its spectrum. TMUS has also adopted a zero dividend policy. Essentially, it is trying to increase its subscriber base via aggressive cost reduction strategies fueled by the income saved through cutting dividends. This report is an update on the company's full year financial performance for the year ended 2013 and also features business updates and catalysts that can potentially affect the future prospects of the company.
Business Highlights 2013
- TMUS added around 4.4 million customers in 2013 making it the fastest growing company in the U.S. telecom industry during the year.
- Launched the un-carrier strategy and started competing on a low cost basis.
- Merged with MetroPCS and listed on NYSE.
- Became an approved iPhone carrier for the first time. This development was one of the reasons for subscriber growth.
- The company expanded its 4G LTE to 95 (out of 100) metro areas of the U.S.
Revenue and EPS
TMUS posted revenues of $24.42 billion as compared to $19.72 billion the previous year. This translates to a growth rate of around 24% which is very healthy. The increase in the revenues of the company was mainly attributable to additional revenues from MetroPCS and the sale of devices, such as the iPhone and Samsung Galaxy S4. Despite an increase in the subscriber base, the revenues from branded postpaid declined. This was most likely caused by the price reduction strategy of the company in the year 2013. The average revenue per user (ARPU) declined and, as a result, the revenues from postpaid customers also declined. Prepaid sales increased because of an increase in the ARPU from prepaid customers. Overall, the strategy to compete on a cost basis was precisely reflected in the company's revenues. The graph below summarizes the revenue position of the company.
*Source: SEC filings
The graph shows that postpaid revenues are declining but equipment sales and branded prepaid grew substantially in 2013, resulting in an overall growth in revenues.
Analyzing the ARPU trend will give us some perspective on the overall revenue trend of the company. Postpaid ARPU declined by 7% in the year ended 2013 while prepaid ARPU increased by an impressive 28%. This explains the decline in postpaid revenue in the current year.
*Source: SEC filings
The postpaid ARPU is expected to fall in the coming year as well. This is because the current penetration of Simple Choice Plans in the postpaid base is 69% and the company expects it to reach around 90% in 2014. Simple Choice, as we know, is competing on a low cost basis. However, the postpaid revenue (in absolute terms) is expected to increase in the future because of an expected 2.5 million net postpaid customer additions in 2014.
TMUS managed to post a positive EPS in the current year. It reported a net income of $35 million as compared to a net loss of $7.4 billion in the previous year. The return to positive income was because of positive movements in revenues and operating costs. Cost of operations declined by 10% despite the revenue increases. There were significant impairment charges in the year 2012 and 2011 but no impairment was recorded in 2013 and hence, overall costs were reduced. If one does not consider these non-recurring expenses, the operating costs were in line with the revenue growth. The graph below summarizes the anticipated EPS position of the company in the coming years.
*Source: SEC filings and yahoo finance
The forward P/E 2015 is around 27 whereas the industry average is around 14 indicating that the stock of TMUS is overpriced even if it posts an EPS of 1.08. We will use a cash flow based calculation in the valuation segment because we believe cash flows truly reflect the prospects of the company.
Cash and Balance Sheet Position
TMUS has a cash balance of $5.89 billion in the most recent quarter. The current ratio stands at 2.11, indicating that the company faces no short term liquidity problems. Moreover, it generated around $3.54 billion in OCFs in the trailing twelve months. This is quite a substantial amount of operating cash and it seems that the company is undervalued, given that it sustains this level of business and cash flows. However, the capital expenditures of the company are expected to be around $4 billion in the coming year. This affects the cash flows as well as the valuation of the company.
TMUS added 4.377 million subscribers in the year 2013 as compared to the 0.203 million added in the 2012 and a total subscriber loss of 0.549 million in 2011. Total branded customer additions were 2.344 million as compared to 1.067 million branded customers lost during the year ended 2012. The price reduction strategy seems to be working for the company and it expects to add another 2.5 million net postpaid customers in the year 2014. The graph below summarizes the subscriber trend of the company.
*Source: SEC filings
Customer retention also improved in 2013. The churn rate was 1.7%, down from 2.4% in the year 2012. We believe that an improved retention rate points to improving network quality.
Overall, it seems that the revenue of the company will increase but there will be a tradeoff between ARPU and revenue growth. EPS will not substantially increase given that the company is planning on significant capital expenditures in the near future but this could be seen as an investment because subscribers added due to a price reduction strategy and retained later because of network improvements through additional CAPEX can result in future EPS and, in turn, valuation gains. However, we do not foresee these gains in the coming two years at least.
TMUS and LTE
T-Mobile is aggressively rolling out LTE. The service is now available to 203 million people in 95/100 metro areas in the U.S. in just less than a year after its rollout. The company also doubled its theoretical speeds in 40 of the top 50 metro markets. This development puts its system at par with Verizon and Sprint in these areas. The company recently claimed in a press release that its 4G network is the fastest in the U.S. and this claim is supported by mobile data speed tests utilizing the popular Ookla Speedtest app, involving more than 1 million consumers. According to the tests, the LTE network delivers a 17.8 Mbps network speed and is also more consistent. This development enhances the standing of the company in the highly competitive U.S. telecom market. Customers were paying premium charges to Verizon and Sprint because of their superior quality but if T-Mobile attains an equal footing in terms of quality, only the network coverage hurdle will remain between TMUS and the giants. Coverage is not a problem for metro area users and hence, metro users are expected to shift to TMUS because of low costs and no contract clauses.
TMUS and ETFs
T-Mobile is offering to pay off the early termination fees of potential customers. According to a press release:
"With an eligible phone trade-in, the total value of the offer to switch to T-Mobile could be as high as $650 per line."
Note that AT&T recently offered to give a $450 credit to consumers that wanted to shift to AT&T from T-Mobile. T-Mobile's offer is most likely a response and with $650 per line it looks like the hurdle to shift from a network due to ETFs is removed. However, one important point to note here is that these developments initiated price wars which will eventually result in low margins and reduced EPS.
T-Mobile's enhanced network and price strategy is expected to attract more subscribers for the company. It looks set to reach its 2.5 million postpaid customer target. However, the price war will result in pressured earnings for the next year or two. TMUS will also witness growth in equipment sales in the year 2014 amid the new Samsung S5 and iPhone6 expected in the fall.
Valuations and Final Thoughts
- CAPM reflects the cost of capital and beta reflects the volatility of the stock.
- OCF will grow in line with the subscriber additions. 11% growth assumed in 2014 and 5% until 2018, no growth after that.
- Company's CAPEX will remain flat at around $4 billion in the coming two years and will decline after that.
- No growth is assumed in perpetuity.
The price target reveals that the shares are almost accurately valued by the market forces. A mere 6% increase is expected in the coming year or two and the PT is justified amid the increased CAPEX, earning pressure due to price wars and a highly competitive and mature industry with little future growth. TMUS will certainly gain market share and subscribers but a high CAPEX along with a price reduction strategy will post a barrier to valuation growth in the coming few years. The company does not offer any dividends and no capital gains to write home about. Therefore, we recommend investors interested for short term gains to avoid TMUS until it starts a dividend program. For investors looking to build a portfolio with a long term focus, TMUS's subscriber growth and revenue growth make it a value investment with solid long-term potential.
Additional disclosure: Equity Flux is a team of analysts. This article was written by our Technology analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.