3 Ways T-Mobile Can Continue Its Climb

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About: T-Mobile US, Inc. (TMUS), Includes: S, T, VZ
by: Michael Henage

Summary

T-Mobile's equipment revenue spells an opportunity for the company in the future.

The company can do better when it comes to SG&A expenses, if it does there is an $800 million opportunity to cash in on.

Layer3's timeline seems to have been pushed up, have investors noticed?

T-Mobile (NASDAQ: TMUS) has been a stock picker’s best friend for the last six months. After trading in the mid-$50s several months ago, the stock has risen to above $70 today. The shares have dropped back a few times, giving investors a chance to jump in. Though significant press has been devoted to whether the company will end up merging with Sprint, there are multiple ways T-Mobile can improve its existing business. Though the shares are trading near their 52-week high, long-term investors have a huge opportunity staring them right in the face, regardless of how the Sprint deal plays out.

Problem or opportunity?

T-Mobile is known for growing its service revenue at a pace that exceeds the industry. However, one way the company can continue its climb, is by addressing what seems to be a disconnect in its equipment revenue. The biggest carriers in the industry, AT&T (NYSE: T) and Verizon (NYSE: VZ), may not be able to keep up with T-Mobile in service revenue growth, but their equipment sales seem to be outpacing the “un-carrier.” Looking at T-Mobile’s equipment results over the last several quarters shows a troublesome trend.

Quarter

Equipment Sales

Equipment Sales Growth

Equipment Expense

Loss

Q1

$2.4b

+15.2%

$2.8b

($400k)

Q2

$2.3b

-7.2%

$2.8b

($500k)

Q3

$2.4

+12.9%

$2.9

($500k)

(Source: Q1 2018Q2 2018Q3 2018)

Just as a quick point of comparison, while T-Mobile’s equipment revenue increased by 12.9% in the current quarter, AT&T posted an increase of 19%, while Verizon grew by 23%. One of the reasons for this disconnect in equipment sales, may be T-Mobile has a significantly higher percentage of prepaid customers than its larger competitors.

It’s no surprise that prepaid customers are more fickle and they may not opt for the best and most expensive equipment. All three of the carriers we’ve looked at, said that higher priced equipment was part of how they grew equipment revenue. T-Mobile has just over 21 million pre-paid customers, AT&T has just under 17 million, and Verizon has just 4.7 million.

T-Mobile’s re-branding of Metro PCS, as Metro by T-Mobile, comes with multiple cheap phone options. At present, Metro customers can get an iPhone SE, or different mid-level phones, by Samsung, LG, and Motorola. Though the phones don’t cost T-Mobile as much as say a free iPhone Xs, giving them away for free causes equipment cost to rise without any increase to revenue.

The good news for T-Mobile investors, is the company is growing its postpaid customers at a faster rate than prepaid. In the most recent quarter, T-Mobile’s postpaid customers increased by 11%, while prepaid increased by 2%. In addition, T-Mobile is seeing strong porting results against other carriers. In the last four quarters, the porting ratio has moved from 1.4 in the first quarter to over 1.7 in the current quarter. Given that T-Mobile has nearly double the number of postpaid customers, and they are growing at a faster rate, suggests equipment sales will be less of a drag on results over time.

An over $800 million opportunity

The second way T-Mobile can continue its run, is by aggressively looking at its costs and bringing them in line with the competition. The company has an opportunity to improve its operations, specifically by improving its spending on SG&A.

In the most recent quarter, AT&T and Verizon’s SG&A as a percentage of revenue came in at 21% and 22% respectively. By comparison, T-Mobile’s SG&A expense has been running over 30% of revenue for the last few quarters. Though some might attribute this higher level of SG&A, as expenses related to the pending merger with Sprint, this simply isn’t the case. In fact, T-Mobile said that merger related costs came to $53 million in the current quarter. Considering the company spent over $3.3 billion in SG&A expenses during the same time frame, the merger simply isn’t to blame.

T-Mobile said in its conference call, that SG&A was related mainly to higher employee related expenses and commissions. This has been a consistent theme, and clearly T-Mobile has some work to do. The difference of roughly 8% in SG&A spending, equates to an over $800 million savings opportunity. T-Mobile needs to attack this line item, because the potential Sprint merger will likely cause the expense to balloon next year.

5G and all its layers

The third way T-Mobile can continue its run, is by running as fast as it can to capitalize on its Layer3 acquisition. Layer3 offers a service it refers to as “the new cable.” T-Mobile has already made it clear that 5G is the company’s next big opportunity. However, what some investors may not appreciate, is how quickly 5G could lead to additional revenue in the TV business.

Right now Layer3 is only offered in a limited number of areas, yet hints from the company’s conference call suggests this business will expand faster than originally indicated. Michael Sievert the COO of T-Mobile, seems to have pushed forward the TV timeline. Last quarter, he said, once the company offers broadband services, “you can offer the TV on top of it.” This seemed to suggest TV would coincide with nationwide 5G in 2020.

This quarter, Sievert made it clear the company plans to be more aggressive. He said, “we are busily building, we have our heads down creating the first TV service for the 5G era.” This would still seem to keep to the same 2020 timeline. However, he made the somewhat surprising comment that, “the TV service will also follow with a mobile TV service next year.” If T-Mobile can begin to monetize its Layer3 acquisition more quickly than anticipated, that’s good news for investors.

T-Mobile or the new T-Mobile, either way seems like an opportunity

I’ve made it no secret that I’m not a fan of the T-Mobile and Sprint merger. My primary issue is, T-Mobile by the numbers is the better performing company. It seems like a strong company feels compelled to buy its much weaker peer to prove a point. That being said, it’s likely that the “new T-Mobile” will be able to compete effectively against AT&T and Verizon.

With that in mind, even without Sprint, T-Mobile has multiple ways to improve and keep investors happy. The company can continue to focus on growing its postpaid subscribers, to the benefit of service revenue and equipment revenue. T-Mobile seems to have a significant opportunity to save hundreds of millions in SG&A expenses. Investors know that 5G mobile and broadband are expected to bring one of the biggest transformations in the telecom industry.

If T-Mobile can ramp up its Layer3 offerings as quickly as it is promising 5G (or quicker), this opens a whole new world of revenue to the company. Long-term investors looking for an opportunity to jump into the stock shouldn’t wait for the next pullback. T-Mobile has been climbing over the last six months and this run should continue.

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.