T-Mobile Investors Face An Impossible Decision

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Includes: S, TMUS, VZ
by: Michael Henage
Summary

The "New T-Mobile" is on pause and investors are waiting with little in the way of answers.

History is an expensive teacher. Do Sprint investors remember Nextel?

This is a rare case when investors should be hoping against a big merger.

Unless you’ve been living under a proverbial rock, you probably already know that T-Mobile (NASDAQ: TMUS) and Sprint (NYSE: S) have filed to merge. This is truly the tale of two companies that are headed in different directions. T-Mobile has been growing subscribers, earnings, and cash flow.

Sprint on the other hand, recently grew subscribers, but the company’s service revenue is declining, and the company is free cash flow negative. According to the merger description website, “This combination will create a fierce competitor able to deliver lower prices, more innovation, and a second-to-none network experience.” This is an apt description, but not the way many investors think.

Where are we at?

T-Mobile and Sprint filed their merger application at the end of April, and the Federal Communication Commission (FCC) usually has a window of 180 days that it takes to review mergers to either approve, deny, or amend the application. The deal as it stands, would see Sprint shareholders exchange one of their shares for 0.10256 shares of T-Mobile. The good news for both companies, is this exchange of shares doesn’t create any new debt as an all-cash or partial cash offer would have.

The combined companies are telling regulators, investors, and customers, that they will bring greater competition and lower prices. Existing customers are being promised, “increased speeds, coverage, and performance.” On the surface, combining the number three and four wireless carriers should make them more competitive against AT&T and Verizon (NYSE: VZ).

Behind the scenes of this seemingly fantastic opportunity, there are a few cracks starting to show. First, this isn’t exactly a merger of equals; this is more like a wolf dragging a sheep away to the slaughter. Sprint (the sheep in our story) essentially laid all its cards on the table for the FCC in a recent statement. The company describes its competitive position without this merger in terms investors should take heed of:

“Despite achieving substantial cost reductions and stabilizing its financial position, Sprint has not been able to turn the corner with respect to its core business challenges.” – “…continues to face declining subscribers and revenue.”

In addition to Sprint’s own admission of its business challenges, the FCC also is putting the brakes on this merger in its own way. The agency paused the 180-day review process, because the companies submitted a “substantially revised network engineering model, a new business model and additional economic modeling.”

This could simply be the companies adjusting to the changing realities of the wireless industry. However, the fact that the FCC took this action over a month ago, the timing T-Mobile and Sprint were hoping for, may already be in jeopardy. The original expectation was to have the merger close the first half of 2019. Whether the merger closes in this time frame, or at all, remains to be seen.

Hard choices

Assuming this merger proceeds, the new T-Mobile is going to face some hard choices. Look at the difference between the best offerings from Sprint and T-Mobile today.

Carrier

Monthly Service

Equipment Cost

Discounts/Incentives

Total Cost

Sprint

$60/mo Sprint Unlimited Basic

$0 (iPhone Xs – Sprint Flex lease)

*4th and 5th lines free

*Hulu included

$180/mo for up to a family of 5

T-Mobile

$40/mo T-Mobile One

$27.78/mo – 36 mo financing

*Netflix included

*$300 rebate (trade in of iPhone 8, 7, 7 Plus)

$271.12/mo for family of 4

(Source: Sprint and T-Mobile – T-Mobile trade in deal)

Of course, there are multiple options available through each carrier. There are also options available for multiple types of phones that may be cheaper or more expensive. However, this example shows what a significant difference there is between Sprint’s best offer and T-Mobile’s best offer.

Of course, assuming the new T-Mobile becomes a reality, the new company will likely offer grandfathered pricing, but at what cost to customer loyalty? If you are a T-Mobile customer, how soon before you reject the idea of paying 50% more for the same phone, the same plan, on ultimately the same network, than a customer coming from Sprint? On the other hand, if you are a Sprint customer, will you accept paying significantly more, once your 18-month special lease runs out?

History is an expensive teacher and it seems like investors are forgetting some key lessons. In February 2005, Sprint announced a deal to buy Nextel Communications for $35 billion. At the time, Nextel’s CEO Timothy Donahue said, “This new, powerhouse company has the spectrum, infrastructure, distribution, and superb and differentiated product portfolio that will drive our continued success.” Sound familiar?

This was a merger of the number three and five players in the wireless industry at the time. Just three years later, Sprint had to take a nearly $30 billion write-down of the Nextel brand. Repeatedly, Sprint’s earnings looked like what happened in March 2012. During that quarter, Nextel lost 455,000 contract customers, yet only 228,000 rejoined the Sprint service. The question facing investors, is the Sprint and T-Mobile merger just a replay of the same nightmare?

What does a combined T-Mobile and Sprint look like?

Assuming T-Mobile and Sprint can find a way to keep regulators happy, merge the two companies, and not cause massive customer run-off, what are investors getting? Looking at what the combined companies offer, versus T-Mobile by itself, should raise some significant questions.

Company

The “New T-Mobile”

T-Mobile

Total revenue

$18.7b – up 1.8%

$10.57b – up 3.5%

Service revenue

$13.3b – up 0.6%

$7.56b – up 5.7%

Equipment revenue

$4.69b – up 2%

$2.32b – down 7.6%

3mo core op. cash flow

$4.92b – up 12.8%

$2.4b – up 14.3%

3mo core FCF per $1 of revenue

$0.02 per $1 of revenue

$0.07 per $1 of revenue

(Source: T-Mobile and Sprint 10-Q reports – b = billions)

If you are a current T-Mobile investor, the first question you should be asking is why exactly does this merger make sense? The new carrier will be larger and have more customers, but at the expense of revenue growth, service revenue growth, operating cash flow growth, and free cash flow.

In addition, looking at how the new T-Mobile stands next to a company it hopes to go toe-to-toe with is telling as well.

Company

The “New T-Mobile”

Verizon

Total revenue

$18.7b – up 1.8%

$32.2b – up 2.6%

Service revenue

$13.3b – up 0.6%

$15.75b – up 0.8%

Equipment revenue

$4.69b – up 2%

$5b – up 17.4%

3mo core op. cash flow

$4.92b – up 12.8%

$8.8b – up 8%

3mo core FCF per $1 of revenue

$0.02 per $1 of revenue

$0.15 per $1 of revenue

(Source: Verizon earnings and financial release – b = billions)

In the end, T-Mobile is gambling on Sprint to grow and expand. However, Verizon generates more revenue in each category, and the company’s cash flow is light years ahead of the “New T-Mobile.”

It’s possible that T-Mobile and Sprint will find a happy medium. The new company may grow its subscriber base, realize expense savings, and better results along the way. However, T-Mobile investors face an almost impossible choice. Do you hold the shares, hope the merger is completed, and that all the promises are fulfilled? The other option is, count on your existing company to continue to be the same un-Carrier competitor it has been for years.

Maybe the best thing that could happen to T-Mobile, is for its current dreams to be crushed by the FCC. T-Mobile could then get back to what it does best, competing without the weight of Sprint around its neck.

Disclosure: I am/we are long VZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.