T-Mobile Earns A Neutral Thesis As Potential Merger With Sprint Collapses

| About: T-Mobile US, (TMUS)


Company posted strong postpaid and prepaid net additions in second quarter.

Continues to invest heavily in network and expand 4G LTE framework.

TMUS suffers from declining ARPU and high churn rate.

T-Mobile US (NASDAQ:TMUS) is the fourth largest telecom company in the U.S. It provides prepaid and postpaid wireless, voice and data services. The company has posted strong second quarter results and has continued its solid subscriber momentum, but I remain neutral on the company. The strong subscriber momentum was offset by a decline of 8.7% in average revenue per unit (ARPU). Furthermore, Sprint Corporation (NYSE:S) has called off the merger plans with TMUS, which I believe is a loss for the company. Also I continue to prefer Verizon Communications (NYSE:VZ) and AT&T, Inc (NYSE:T) in the telecom space.

Subscriber Momentum

The company reported postpaid net ads of 908K. The solid subscriber momentum was driven by solid phone only net ads of 579K, the highest in the industry. Of these 579K phone net ads, only 85K subscribers migrated from the company's prepaid segment. The remaining 494k subscribers were added organically. The company recently announced that it now has 15.64 million wireless prepaid customers and has become the largest player in the prepaid market place. In the second quarter of the year, TMUS added 102K prepaid net ads, which highlights the significant improvement from a loss of 87K in the second quarter of the last year.

I am expecting the subscriber momentum to continue in the second half of the year as well due to strong smartphone sales expected with the launch of the iPhone 6 later in the year. Furthermore, the company has reduced prices for families, which will attract subscriber growth in the future. TMUS itself has raised its postpaid net ads guidance for 2014 to 3.0-3.5 million from 2.8-3.3 million.

However, the declining ARPU is a worrying sign for investors. It declined by 8.7% YOY in the second quarter and reached $49.32. So, the strong subscriber momentum was somewhat offset by the declining ARPU. Although TMUS managed to stabilize its postpaid churn to 1.5% in the competitive environment, it is still way higher than the 0.94% and 0.86% churns of its peers, VZ and T, respectively.

Other Important Indicators

The company's 4G LTE framework has expanded to 325 metro areas and is available to almost 233 million people. Wide-band LTE has been launched in 17 markets and it is expected to reach 26 markets by the end of the year. It also started to deploy 700 MHz A-band spectrum, which will increase its coverage and hence reduce roaming expenses. But still the company's 4G LTE outreach is less than VZ and T.

TMUS also reported that it had the fastest 4G LTE download speeds of 19.3 Mbps, followed by VZ, T and S. Furthermore, it is also ranked the highest in wireless customer care by J. D. Power.

MetroPCS' integration is also going faster than expected. Nearly 66% of MetroPCS' customer base has been captured by TMUS and almost 60% of the spectrum is integrated to the GSM network. It has helped the company expand its prepaid customer base to 15.64 million, the largest in the U.S.

Merger Talks Break Down

In my previous article, I discussed that the joint bid for the spectrum auction was just an attempt to build a case for a merger between TMUS and S. Both these companies were trying to show regulators that by bidding together, they could compete more aggressively with larger telecom giants. It was difficult to convince the FCC because TMUS was already competing well with its highest subscriber growth in the first quarter of the year. On the other hand, S failed to attract investors even though it holds the largest spectrum, which is key to improving network quality.

Recently, S decided to back down from its plan to acquire TMUS because it failed to win approval from regulatory authorities. Tom Wheeler, the Chairman of the FCC said last Wednesday; "Four national wireless providers is good for American consumers." It came as no surprise when the FCC, like it has in the past, rejected the deal between T and TMUS. Furthermore, this statement has made it crystal clear that there is no future consolidation expected among the top four.

However, I believe the competitive pressure will further build up in the telecommunication space. S has announced to appoint a new Chief Executive, Marcelo Claure. His focus will be to complete its network transformation and leverage its large spectrum holdings to provide a superior network experience to its subscribers. Furthermore, I also believe that soon S will also start to aggressively compete with lower pricing to attract new subscribers. TMUS and T are already successfully implementing this strategy. Mark Stodden, an analyst at Moody's Investor, is reported to have said, "Without the ability to compete on scale they are going to have to compete on price, so the two smaller competitors may become increasingly desperate to maintain market share and could become irrational in pricing, which could cause disruptions in pricing in the industry."

Overall, I believe this is a loss for TMUS' shareholders, as the company was trading at the highest Enterprise to EBITDA multiple of 7.93x, among its peer companies. Also, it was expected that S would pay some price in the range of a high $30 to low $40 per share for TMUS' shares. At that time, the price of the share was around $32, which meant significant benefit was in store for TMUS' shareholders in a merger scenario. Furthermore, as mentioned above, competitive pressure will increase from S, as it will also start to push its services at lower rates.

Final Words

The company posted strong postpaid and prepaid net additions in the second quarter. It also continues to invest heavily in its network and expand its 4G LTE framework. However, the declining ARPU and high churn rate, relative to its peers, makes my stance neutral on the company. Furthermore, S and TMUS failed to win over a perceived approval from the FCC for a possible merger, which does not bode well for TMUS.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.