T-Mobile: Merger Or No Merger, There's Also Another Problem

About: T-Mobile US, Inc. (TMUS), Includes: NFLX
by: Max Greve

T-Mobile's merger continues to be belabored by regulatory scrutiny.

The company also appears to be leaning towards modifying or even terminating its partnership with Netflix.

This could potentially inflict a real blow to the brand of T-Mobile with its customers, in turn shifting investor sentiment in a negative direction.

At least in the short term, I see headwinds, and have ended my long position in T-Mobile. I will keep an eye for a chance to buy back in at some point.

Last year, after staying away from T-Mobile (TMUS) for almost three years, I recommended again going long on the stock. Over the succeeding year, it has risen roughly 14%, but the key issue hanging over the stock now is the merger with putative rival, Sprint (S). That seems to be driving virtually all of the trading in Sprint, and a substantial portion of the trading in John Legere’s company as well.

There’s enough analysts spilling ink over T-Mobile’s merger situation that I didn’t feel it would be helpful to rehash it again. But I did want to go over another issue that I think has been somewhat overlooked in all the merger speculation. And it involves another of T-Mobile’s partners. A partner who may be inadvertently threatening one of T-Mobile’s biggest assets, its brand cache with consumers.

Netflix News

As most investors probably know already, Netflix (NFLX) has conducted another price hike, this one even more substantial than the last. It’s Standard and Premium plans (two and four streams) are going up by $2 each, and for the first time ever, its Basic plan is going up $1. For the first time since launching streaming as a separate service almost a decade ago, Netflix has no streaming plan priced at $7.99. The rate hike also applies in countries where Netflix denominates its price in US dollars, such as most of Latin America, though not Mexico or Brazil.

The price hike will take effect for existing customers in May, though apparently not until the end of May. I am a Netflix subscriber myself, and I am currently showing one last month at the old price on my billing page. At any rate, prices are going up soon. Probably no later than the end of the month, since I have already received notice about a pending increase. I am probably not an atypical customer.

Caught Up In The Net

Other contributors have already examined the impact of the hike on Netflix itself. But the impacts extend beyond streaming video providers. This price hike also has significance for T-Mobile, which launched its Netflix On Us promotion as part of its Uncarrier Revolution in September 2017. Under the deal, T-Mobile covers the cost of a Netflix Standard plan (two-stream plan with HD) and members may choose to upgrade to a Premium plan (four-stream plan with 4K) and pay only the difference out of pocket. The Netflix promo is only available to family plans (two lines or more) and customers have to be on the latest T-Mobile ONE plans.

At the time Netflix launched the promotion, the Standard plan cost $9.99 per month, which meant that T-Mobile was essentially sending $10 out of the $120 a two-line family plan was sending them right back out the door. Expensive, but for a company with high-fixed costs, worth it if it attracted customers in large numbers, which it apparently has since T-Mobile’s growth has only accelerated since then.

The downside, however, is that the deal contained no restrictions on what the price of Netflix would be in the future - Netflix would never have agreed if it did - and consumers generally expect companies to maintain their services. This leaves T-Mobile in the position that is a little uncomfortable like those of traditional pay-TV companies like AT&T (T): its content suppliers can hike prices behind the scenes and leave them to do the unpopular part of, in turn, hiking prices on actual consumers.

Apparently, They Won't Pay Up

What makes it even worse in T-Mobile’s case, however, is that it isn’t even a middle-man so much as a patron for consumers - it promised subscribers free Netflix, not to re-sell them Netflix. And because it has made Netflix On Us a major part of its marketing for almost two years now, it has become an intrinsic part of the Un-carrier branding. And it just keeps getting more expensive.

Netflix has already conducted one price hike since then, a single $1 increase across all plans. T-Mobile covered that increase to maintain the Netflix On Us promo. T-Mobile says that “for now” it will cover the cost of this second, larger hike itself as well. This was only supposed to be binding until May 1st; however, T-Mobile said it was “in discussions” about what will happen after that.

From the fact that May 1st has come and gone with no announcement, we can infer that discussions are still ongoing, and presumably are not yielding entirely satisfactory results thus far.

A Near-Term Headwind

By no means is it all doom and gloom for T-Mobile, but there is a substantial problem for its brand here. Essentially, it must either continue to absorb price hikes itself or reverse itself on a major Un-carrier initiative, and its brand power has been built in no small part on the endurance of the latter.

T-Mobile could also decide to cover the plan with a premium for the Standard plan, much as it already does for the Premium plan. Since Netflix only cost $10 when T-Mobile started out, and T-Mobile already followed the first price hike up to $11, it could continue to supply the same $11 and tell customers they are on the hook for the difference. The $11 would still be enough to cover half the cost of the upgrade from Basic to Standard, and if customers didn’t want to do that, they could still have the Basic plan fully covered.

But again, the question becomes how much damage to T-Mobile’s brand would this do? Technically, they would still be offering free Netflix, but customers would almost certainly notice the decay in the quality of their streams. While we are only talking about a few dollars per month for T-Mobile, investor sentiment could turn if T-Mobile decides not to stretch its own budget to maintain its commitment to its customers and suffers a brand hit. And the length of the talks suggests T-Mobile is not willing to simply take the hit.

The Un-Carrier Is Still A Carrier

It might be objected that this kind of thing simply won’t happen, because the carrier’s management is sincerely opposed to treating the customer in this fashion. But as I’ve noted before, T-Mobile has always raised prices whenever they thought they could get away with it. They tend to retreat from such price hikes only when such increases get too much press attention, threatening their un-carrier image; or when competitive pressure from another low-utilization carrier (that would be Sprint) makes hikes untenable.

There have been hikes of more recent vintage, as well. T-Mobile raised the price of its 55+ plan to $70 from $60. Not long after, T-Mobile discontinued offering its discount option KickBack on all T-Mobile ONE plans that hadn’t already signed up for it, essentially hiking prices on low-data lines by $10 per month per line. Accounts already approved were grandfathered, though.

In other words, T-Mobile hikes prices, but only when it thinks it can do so quietly. A Netflix On Us reversal would not necessarily be quiet.

Investment Conclusion

As an investment, T-Mobile has served me well for the last year and change, but merger uncertainty is rising and the trade war is becoming a drag on the market in general. I was prepared to tough it out, but this other problem on top of everything else has me thinking that at least in the near term, T-Mobile could hit a bump. With the stock above $74 as of this writing and a near-15% gain in a year, I’ve decided for now to take some chips off the table and end my long on T-Mobile. I still think it has long-term potential, but I am looking to avoid some near-term downside and perhaps buy back in later at a better price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.