Description

Investment thesis

T-Mobile US, Inc. (“TMUS”) is the second largest wireless phone carrier in the US with 104.8mm total customers. The company, along with Verizon (“VZ”) and AT&T (“T”), is one of three scaled facilities-based carriers that together account for 98%+ of wireless traffic in the U.S.

The company is currently in the later stages of a decades long transition from “worst to first” (or perhaps second). Extraordinary execution, subpar performance from the competition, and two important acquisitions have had an outsized impact on the company’s current competitive position. Despite its impressive growth (see below), the company still has two large opportunities in: (1) previously under-tapped smaller and rural markets as well as (2) the enterprise market. Given the company’s lower prices, network, spectrum position, and superior customer service, we believe that they will be successful pursuing these two opportunities.

The company currently has a low-teens market share in the 50mm households that comprise the smaller and under-tapped market described above. On the enterprise side, there are 50mm corporate-liable lines where the company’s market share is just below 10%. Importantly, these two markets provide TMUS a layer of protection to keep gaining subscribers at comparable economics should the competitive environment deteriorate.

TMUS has gone from being an unprofitable, subscale, regional wireless operator eight years ago, to a national contender on the network side and share taker within the industry. This has happened in a mere eight-year timeframe since John Legere unveiled his “un-carrier” strategy. In a business where incumbents have focused on exercising their market power at the expense of customer satisfaction, Legere focused on offering products that are consumer centric at lower prices.

Despite having had a clearly inferior network, the combination of relative consumer centricity and lower prices has allowed the company to grow its subscriber base. The organic growth, along with the Metro PCS and Sprint (“S”) acquisitions, have allowed the company to create a network that is comparable to VZ’s and T’s, and to achieve a spectrum position that is unmatched in the market. In a business where scale and spectrum position are paramount, the company now has the second biggest network, the best spectrum position, and the lowest pricing. The chart below depicts market share over time. Later in the write-up we expand on TMUS’ relative spectrum position.

Having said that, low pricing without a corresponding low-cost position can hardly be considered a structural competitive advantage. TMUS has historically operated at a noticeable unit cost disadvantage to its peers. That will change by 2026 (see below). Naturally, the question arises as to why TMUS should continue to gain share and excess returns by merely accepting a lower margin? That’s because lowering prices is too tough of a pill to swallow by VZ and T given that they would have to reprice most of their customer base within a few years. VZ would be impairing its premium brand and the pricing on their MVNO, T would be playing a game with a clear disadvantage as they will now have the highest unit cost structure, and they both would be taking on a tremendous financial risk because if everyone responds there will be no sub gains to compensate for the lower pricing. For illustrative purposes, we estimate that a 15% decrease in postpaid prices across the board for both T and VZ (which would make their prices still slightly higher than TMUS’) with no associated increase in subscriptions, could translate to a $9bn decrease in pre-tax cash flows for VZ (or 27% of wireless EBITDA-Capex) and a $7bn hit for T (or 35% of mobility EBITDA-Capex).  That’s a lot of downside for limited and uncertain upside, especially given the fact that both companies are still able to eke out small customer additions in the current environment.

In Q4 2019 VZ changed its reporting structure and no longer discloses the costs associated with its wireless business making it difficult to project. For T 1/3 of corporate expense is allocated to Mobility, for VZ half of corporate is allocated to wireless.

To be clear though, TMUS does not have a massive cost advantage that would guarantee lower pricing, or a value proposition that absolutely cannot be copied. That means, to us, that they are not as tightly in control of their destiny as they could be. This introduces some degree of uncertainty, though we are comfortable with this heightened uncertainty as it is difficult for us to construct a scenario where TMUS is meaningfully impaired. Said differently, while the range of outcomes may be wider, we believe the downside is limited if we are wrong.

Since TMUS’ “un-carrier” strategy was revealed in March 2013, the company’s shares have compounded at 32% (not a typo). Despite the strong track record and runway, its shares are trading at under 7x our estimate of 2026 earnings. Using a 5-year DCF with 2% terminal growth and a 10% discount rate, we think the company’s shares are worth $171 per share which implies 21% upside. That translates to a 15% IRR over a 5-year period. More importantly, we think the downside is particularly limited given (1) their under-tapped market opportunities, (2) their network and spectrum position and (3) the high levels of customer stickiness within the industry with churn at less than 1% a month for all three carriers.

Our thesis is predicated on the following 3 points.

1. The underpenetrated smaller/rural and enterprise markets should provide a long runway for market share gains and revenue growth.

2. TMUS’ current spectrum position provides ample capacity well into 5G, takes away the necessity to acquire spectrum for many years, and puts the company within striking distance of having the best network.

3. The company should be able to successfully execute its S acquisition plan.

Company description and industry background

TMUS provides wireless connectivity across the US. It earns revenue in three different ways: by charging a subscriber a recurring fee for access to its network, selling telecommunication devices (mainly phones), and selling wholesale capacity to other communication providers in the form of MVNOs. Of those three, the devices are not a profit center and are generally used as a subscriber acquisition and retention tool.

The company’s biggest contributor to profitability is its consumer business (as opposed to wholesale). The business provides access to its networks in the form of postpaid and prepaid plans.  For 2020 the company’s service revenues were composed of postpaid at 72% of revenues, prepaid at 19%, and wholesale roaming and others at 9%.

On the cost side, the company’s most significant expenses relate to operating and maintaining the network (mainly tower leases and backhaul), acquiring and retaining customers, managing a retail footprint, and paying employees. Networks are generally perceived as being high fixed cost businesses, though they also have variable cost components. On the fixed side, a national carrier needs to be able to provide coverage across the US, acquire a certain amount of spectrum, and operate a large retail footprint, amongst others. On the variable side, twice the number of subscribers within a dense market requires more towers and radios than a smaller subscriber base.

Short industry background

Prior to 1984 there was a legal telecom monopoly in the US, which was then broken up by the DOJ when The Bell Company was broken into the seven baby bells. Wireless telecommunication was only getting started then with the first consumer cellphone introduced in the US that year. The breakup caused a number of new entrants to emerge, but the seven baby bells were still by far the most relevant. Given the advantages that scale provides within the industry, in 1996 (with newly granted permission from the government) the baby bells started acquiring each other. Given the inherent value in the respective networks and subscribers, all the bells either acquired or were acquired. Six of the seven were rolled into the companies we currently know as T and VZ (see below). Neither TMUS nor S emerged from the baby bells. TMUS’ original predecessor was Western Wireless. 

Over a period of  approximately 10 years the industry aggressively consolidated, with VZ and T emerging as the clear scaled players. The other two players left in the market, TMUS and S were clearly subscale and without the Bell pedigree. The industry structure allowed the scaled competitors to dominate (see Exhibit 1 in the Appendix).

From the time the wave of consolidation began through 2014, VZ and T controlled the market. That is when TMUS’ transformation began. In 2013 TMUS acquired MetroPCS, increasing their sub count by 39% in one year. Then from 2014 to 2019 it added 38.4mm subs organically, and in 2020 acquired S to become the nation’s second largest carrier. With the S acquisition, the industry structure changed from a four-player market (with two dominant competitors) to a three-player market with three scaled companies.

Between the big three carriers, cable, and Dish there are 338.7mm connections in the US, which has a population of 328.2mm (23.6% are younger than 18). There are more connection than people. That has led many to believe that the industry is near saturation. We think it is more nuanced, but this is certainly not a high growth industry, even if there is an increased proliferation of connected devices, or if other use cases emerge.

Thesis

1.   The underpenetrated smaller/rural and enterprise markets should provide a long runway for market share gains and revenue growth

Despite being the country’s second biggest wireless network, TMUS grew from being a largely regional wireless carrier. That means that the company’s historical footprint, both on the network and distribution sides, were focused on certain areas of the US. The coverage map from 2014 (below left) is a good illustration of the legacy network’s regional nature. As the map shows, the company had coverage in most of the big cities but was lacking in large areas outside those cities. Since then, the company’s network has drastically expanded (below right), and while their distribution has also expanded, it has done so at a much slower pace. The network expansion had to be prioritized as it dramatically improves the value proposition and relative competitive position of its wireless product.

Given the historical backdrop, the company is under-indexed in smaller and rural markets on the consumer side. Wireless plan purchases, especially switches, have historically taken place inside a brick-and-mortar store. A lack of physical distribution and targeted advertising naturally results in a limited presence. As previously mentioned, the company segments this opportunity by calling out 50mm under-served households (out of 121mm households in the US) where the company has had this historical handicap and where current market share levels are, in aggregate, in the low teens. While there is no publicly available data to corroborate management’s guidance, we do know that TMUS’ market share in large cities is higher than their overall market share of 30.7% (below).

Going into new geographical areas is a process that takes time and capital. It requires the company to open physical locations. It also takes time to gain market share once a market has been entered. With monthly churn for VZ and T ranging from 0.8% to 1.0% per month, it would take 8-11 years for all subs to be out shopping for a plan (excluding the fact that churn is amplified by a cohort of subs that churn more often).

What gives us conviction that TMUS will be able to successfully gain share in these markets?

TMUS has a national brand, offering lower pricing, operating a comparable/better network in the area (more on this later), and entering markets with lower socioeconomic characteristics. It’s just a better value proposition. At the same time, while VZ and T have some competitive responses, it’s hard for them to respond aggressively as whatever their response is has to apply to most of their installed base (at least in that market). A simple example might help drive this home. In a market where both VZ and T have 50% market share and 30% EBITDA-Capex margins, it is cheaper for both VZ and T to give up 15% market share (over 5+ years, to end up near 33% share) rather than lowering prices by 15% (or giving that amount of value to the customer in a different form). Price is more expensive to give as it goes straight to the bottom line. In addition, while less relevant, we have heard that some of these smaller markets tend to not be a priority for VZ and T.

We have also seen the company do it successfully. In addition to management commentary, our primary research has confirmed the company’s success in entering new markets. Reading through earnings transcripts there is a progression of market share in smaller and rural markets from 3%-5% in mid-2017 to the low teens today. Additionally, in our conversations with industry participants, we have heard that the company tends to achieve market share gains of 5%-10% per year in new markets (more heavily weighted towards the 5%) until they reach a market share near 33%.

Understanding how the company goes about entering new markets might give further insight into the probability of success. The company has a system where they rank different markets in order of attractiveness. In their rankings they have measurements such as data usage, buildability, competitive dynamics, and demographics, amongst others. They focus on the highest ranked. Once they decide to build out a market, they put together a network strategy and a sales/distribution strategy. The network needs to be built out to a minimum standard, and no real distribution tends to take place until the network is ‘at least as good’ as the competing offerings in that market. On the distribution side, the company engages in temporary promotional activity and ensures that they are the price leaders. There would also be an advertising campaign.

The above might seem like a lot of capital to spend on a small market, which might be a way to gain subs at the expense of profitability.  We don’t think that is the case. Our work suggests that TMUS earns a compelling return on these buildouts.  They target 5-7 year paybacks which translate to 15%+ ROICs. According to our estimates, the company can generally reach that target by capturing a mid-teens share of the market they enter. As per the above, it usually takes them two to three years to reach that level of penetration.

This section has focused on the consumer market, that’s because consumer is where we assume the most net additions and the dynamics are a little more nuanced. On the business segment, the situation is more straightforward. A network that is now comparable to VZ and T’s on 4G LTE (according standard-bearers Opensignal and Rootmetrics) and ranking better on 5G (Opensignal), while offering lower pricing, is bound to gain market share where the consumer is sophisticated and thinks about cost rationally. The company has been gaining share in this segment. The business segment also has the added benefit that its likely to grow at a faster rate than the general population, which would provide a tailwind for the industry.

2.   TMUS’ current spectrum position provides ample capacity well into 5G, takes away the necessity to acquire spectrum for many years, and puts the company within striking distance of having the best network.

The wireless industry has two important differences when compared with their cable counterparts: (1) wireless competes nationally whereas cable competes locally, and (2) wireless carriers need to own/acquire spectrum to provide their services. While point 1 has been important for TMUS’ success, point 2 is a negative for the industry. It does not help that spectrum is a finite asset that is generally acquired from the government in an auction where there is price uncertainty. Spectrum position can also have a tremendous impact on the relative quality of a network. As a result, we spent a long-time understanding TMUS’ spectrum position.

In Exhibit 2 we lay out each major wireless company’s spectrum position in more detail. The punchline is that TMUS currently has a tremendous amount of excess capacity and has a large gap with their two major competitors. TMUS’ acquisition of S had the important benefit of drastically expanding the company’s spectrum holdings. The most important of which was the ~175MHz block of 2.5GHz spectrum, which is the widest block owned by any of the three carriers, and which has superior propagation characteristics than C-Band (VZ and T’s most important mid-band spectrum), albeit at slightly lower speeds. For more information on the differences between 2.5GHz and C-Band check out pages 31 and 32 of TMUS’ most recent investor day, as well as Exhibit 3.

While our analysis is not perfect and real life is more complicated, we calculate that TMUS’ current spectrum capacity, measured as bits/second/tower, is five times that of VZ’s and T’s (pre C-Band). We make the comparison to pre C-Band VZ and T because that spectrum does not start clearing until December of this year, so it is an accurate representation of their current capacity. The comparison is particularly interesting relative to VZ. VZ currently has 121mm wireless connections, or around 17% more than TMUS. If we assume the average TMUS sub uses a comparable amount of data to the average VZ sub, we see that TMUS has six times as much capacity per sub as VZ. If we assume that mobile data needs increase by 25% per year for the foreseeable future, it would take 8 years for TMUS’ network to reach the level of congestion that the current VZ network has. The VZ network does not currently have any congestion issues. The way we interpret this is that TMUS can go many years without having to acquire material amounts of new spectrum. It does not mean they will not do it; it just means they do not have to.

We can try to quantify how much it would cost VZ and T to reach mid-band spectrum parity with TMUS. Word of caution, this exercise is only for illustrative purposes and requires many difficult assumptions, but it helps put some brackets around the spectrum advantage. As per the below, it would cost T approximately $22.5bn to reach mid-band parity with TMUS, while it would cost VZ roughly $9bn.

As we think about spectrum longer term, all three companies will have to acquire spectrum in the future to address growing capacity needs. While our purchase price and time-value-of-money de-risks some of that risk, there is uncertainty, especially as we move into 6G and beyond. The real risk is that competitors bid irrationally and impair the industry’s profit pool. We book-end that risk by looking at the earnings power of each business.

As the above shows, once dividends are considered, TMUS’ spending capacity is significantly larger than that of VZ and T. Of course, dividends are not contractual obligations, and T just reduced its dividend in connection with the WarnerMedia spin. Nevertheless, anyone close to these companies knows how important the dividend is to their investor base and lowering the dividend to buy spectrum is not a place where these companies want to be. While not bulletproof, the combination of the current spectrum position, the runway it provides, and the different companies’ likely future spending capacity, the present value risk associated with spectrum spend is limited.

The spectrum discussion brings to the forefront the question of network superiority. It is common for industry pundits to argue that TMUS will have the best network as we transition to 5G. Our position is that we just do not know. There is more that goes into a network than spectrum and the higher-level design details disclosed to the public. Having said that, we do believe that TMUS is in a good position and at the very least within striking distance of being the best network.

From our perspective, there are three irreplicable proprietary assets that each network has: (1) its spectrum position, (2) its subscriber base (i.e. scale) and (3) the network design. Everything else is readily available for a reasonable price; the latest technology and equipment can be purchased, tower space is not an issue and everyone has access to the same phones. TMUS ranks well in all three. We do not see a compelling reason why the company’s network would not be on par with VZ’s and better than T’s as we get into 5G.

To summarize, TMUS’ current spectrum position provides ample runway for capacity usage growth, which means that the company’s spectrum needs should be limited in the medium term. As we look at the network more broadly, it is in a good place to compete with the other two carriers.

3.   The company should be able to successfully execute its S acquisition plan.

TMUS’ April 2020 S acquisition was transformative (it was technically a merger but we see it as an acquisition). The company exited the year with 19% more subs than in the previous year (after remedies), acquired the spectrum we wrote about, increased total towers and cell sites by 94% and grew its retail footprint by 54%. There are two main components that will determine the success of the acquisition, (1) the cost synergies achieved and (2) the reduction in S subscriber churn. In our view, the probability of achieving these is high. It is notable that our view here does not seem to be particularly differentiated. Nevertheless, we make it a thesis point as it is an important component for achieving the cash flows we expect them to achieve.

Cost synergies

The company has guided to $7.5bn of synergies. Most of the synergies come from the network. The largest portion of the synergies come from tower leases which comprise $5bn of the total. Of that $5bn, $3bn is related to tower decommissioning. The company does not need all of the 108k macro towers that it currently has. The other $2bn in synergies are what they call lease avoidance costs, which are leases they would have done had the merger not taken place. There is coverage overlap that would have been necessary to operate two separate networks, but is unnecessary when operating a single network. The $2bn ‘avoidance’ bucket is easy to understand and riskless, though management has a lot of flexibility in the number they disclose. The $3bn of site decommissioning is more complicated as there are currently contracts in place with the tower companies.

Since the merger closed, the company has had a long time to work on the tower agreements. In September 2020 the company announced a new MLA with American Tower. Both Crown Castle and SBA have spoken about the average renewal term with TMUS which we estimate would be 4.5 years at present. They both have a certain number of yearly renewals. Crown Castle does seem to have a larger renewal in 2023. In our view, the question about sites is not a matter of if but a matter of when. Management’s plan for 35k macro sites by the end of 2022 seems reasonable, and given the contractual nature of the leases, they must have good visibility.

The remaining $2.5bn of synergies are related to SG&A and are generally intuitive. As a result of the merger, the company now has at least 30% more company-owned stores than VZ and T, and there are stores in overlapping locations. The advertising budget will be decreased. There are also a lot of duplicative functions such as IT, billing systems, logistics, senior management, procurement, etc. that can be eliminated at little cost to the business and operations. 

Reduction of S churn

The three main idiosyncratic determinants for churn tend to be the following: network, customer service, and customer demographics. Competition is important but not idiosyncratic. The below chart has legacy TMUS and S historical churn statistics. Consistent with what we have written, TMUS has done a tremendous job lowering their churn levels, whereas S’ had been steadily deteriorating since late 2015.

Legacy S network and customer service issues are widely understood and have been going on for many years. One way to summarize it for those unfamiliar with the company is by looking at NPS, which according to Customer Guru is 5 for S, and it compares to 35 for TMUS, 15 for T, and 7 for VZ.

With the improvement of both network and customer service, we are bound to see an improvement in churn. Furthermore, the socioeconomic characteristics of the customer base, i.e. the third churn determinant, came with the acquisition. A ‘worse’ customer demographic might just be more predisposed to churning. While there is no perfect data, we found a few datapoints that indicate that there isn’t a big socioeconomic difference between the TMUS and S customer base. In other words, the S customer base should not be an obstacle to reducing churn. Below are two charts that we found instructive.

The fixed wireless opportunity

The company is in the early stages of rolling out its 5G enabled fixed wireless product. The current price is $50 per  month with autopay (down from $60 a few months ago) and it offers download speeds of up to 100Mbps with average speeds closer to 50Mbps.

In our view, the offering is not particularly compelling for a cable ‘overbuilder’ given the speed and price. However, it is a very compelling offering for unserved and underserved markets, which tend to be served by a copper infrastructure that struggles to provide download speeds above 25mbps. The offering is significantly better than current alternatives in these places, and the product works well. There are a number of independent user generated YouTube videos that provide context for the quality of the product and what it means for people living in underserved/unserved areas.

From a capacity perspective, the project fits well within TMUS’ smaller and rural market opportunities. As mentioned, the company’s process when focusing on a market includes working on the network. In a lot of these areas, the company owns significantly more mid-band spectrum than could be reasonably consumed through a wireless offering. The cost of lighting up that additional spectrum is small, which makes the broadband offering a neat solution for monetizing some of the spectrum that wouldn’t otherwise be monetizable.

While we are skeptical that the company will be able to achieve any meaningful market share in areas with a competitive ISP footprint, we do believe the company will be successful expanding in unserved/underserved areas. In their analyst day, the company guided to 7-8mm broadband subscriptions by 2025. We err on the conservative side and assume just under 2.5mm subscriptions by then with average ARPUs up $53 (assuming 2/3 of subs select autopay). We also, somewhat arbitrarily, assume margins ramp up to 50% by then given the little additional resources that the offering takes. That translates to about $780mm of pre-tax FCF for 2025 and growing slightly to our terminal 2026 year. In its totality, fixed wireless increases our estimate of intrinsic value by 6%.

Management and share ownership

What TMUS management have achieved in the last eight years cannot be overstated. They overcame significant scale disadvantages and network shortcomings in a business where scale and network are paramount. For that, John Legere and his team take most of the credit, though VZ and T have had some missteps. During Legere’s tenure, shares of TMUS compounded at 25%. Legere stepped down in April 2020, and his COO Mike Sievert took over as CEO. Sievert has been a top lieutenant of Legere’s since the early days and the executive team has only had minor turnover since Legere assumed the top role.

We are not fans of the way Sievert conducts himself towards competitors and would prefer him to be less promotional. We can live with those shortcomings, though, as our checks have been positive, and he has been key in executing Legere’s strategy. Our understanding is that there is a strong culture within TMUS (for a large wireless carrier). Employees are generally energized and productive, and taking reasonable risks is encouraged.

It is worth noting that the people closest to the company, some of whom are no longer involved with the company, are still large shareholders and have not really sold since departing (as far as we can tell there is no clause impeding them from doing so). Specifically:

-          John Legere still owns $384mm worth of shares, no sales

-          Former S CEO and current board member Mercelo Claure owns $1bn worth of shares, no sales

TMUS is controlled by DT who owns 52.1% of the shares outstanding and a higher percentage of the voting power. They are looking to increase their ownership by acquiring Softbank’s 106.3mm shares (8.5% of shares outstanding). TMUS is DT’s most important operation. Their shares currently have a value of $93.6bn which is just under the company’s market cap of $99.8bn (the EV is $301.2bn). DT’s CEO is TMUS’ chairman.

Why might TMUS be mispriced?

TMUS is a well-covered 178bn market cap company. A lot of the analysts covering it seem to have a relatively good grasp of the company and industry (though we have yet to see one that includes spectrum acquisitions in its projections). The company has a strong track record, and in their recent investor day, they lay out the thesis for the company reasonably well.

This naturally raises the question of why TMUS might be mispriced. In our diligence, we struggled to find a compelling bear argument. We heard reasons such as:

-          Execution risk around the S integration.

o    Response: see thesis point 3.

-          A deterioration in the competitive landscape.

o    Response: This is a risk that we expand on in the risk section.

-          “Wireless is a bad industry.”

o    Response:  Agreed. TMUS has created what we think is a sustainable competitive advantage in a mediocre industry by taking advantage of some of their competitors’ weaknesses.

Given the lack of a strong negative argument, it might be instructive to look at relative valuations for clues. According to our model, if we were to exclude future spectrum purchases, the company would be trading under 6x our estimate of 2026 FCF, that compares to around 7x for VZ and just under 7x for T (both adjusted for dividends). Some qualifiers:

We know that this isn’t perfect. The different companies don’t all have the same mix of businesses; though none of the other businesses are large enough or particularly ‘attractive’ to change the conclusion. We use sell side estimates for VZ and T, which are reasonably narrow, but they might not be an accurate representation of the market. Note that sell side estimates don’t include spectrum purchases, which is why we exclude them for TMUS on this exercise. Note that for T we are using the share price before the announcement of the WarnerMedia spinoff as the sell-off since it is clearly idiosyncratic and not a testament to the mobility/broadband businesses.

The differences in multiples aren’t staggering, though TMUS definitely trades at a lower 2026 multiple than its two main competitors. Should the company execute the way we expect them to, it is difficult to believe that the company’s shares would trade at a lower multiple than VZ and especially T. In 2026 TMUS should still have room in its under-tapped markets, lower pricing, a better capital allocation track record (not a high hurdle), and a cost advantage over at least T. That suggests that the market, in the aggregate, disagrees with our 2026 estimates – as opposed to a terminal multiple question. There are only three areas that would most likely explain the difference:

• Sub count (i.e. quantity): As per thesis point 1, we are willing to bet on sub growth.

• ARPU (i.e. price): ARPU deterioration would come as a result of a more competitive environment. For ARPU to deteriorate materially VZ and T would have to decide to earn a lot less which we see as unlikely. Given VZ and T’s higher prices, they would be more at risk of pricing pressure.

• Margins: Any differences in margins would most likely be a result of the S merger. See thesis point 3. To the extent that margins are responsible for the difference in cash flows, it would likely be a general aversion to M&A execution risk rather than a specific argument.

Valuation

For TMUS’ valuation we project five years out to 2026. We assume that the company will start generating FCF in 2023 which will be mainly used to repurchase shares at increasing prices. Then we assume 2% terminal growth on year five earnings and apply a discount rate of 10%. We also assume the company maintains 2.2x Net Debt/EBITDA, which translates to some small re-leveraging in 2025 and 2026. Below the main drivers of the valuation.

-          Revenues: We assume a 19.1mm increase in postpaid phone subs to 2026 and a 1.5mm increase in prepaid. Flattish ARPU for both postpaid and prepaid. That results in revenue CAGR of 3.6% from 2021-2026. We build up to our 20.6mm total phone adds the following way:

o    11mm small market/rural phone additions: 50mm households in this group * 2.2 lines per household * 10% increase in penetration (from low teens to low 20s).

o    5mm business additions: 50mm current corporate liable lines * 5% annual market growth * 6% increase in market share (from just under 10%).

o    4.6mm in organic additions: this represents ~85bps annual increases from the current base, which can be justified through 50bps of annual population growth and very small competitive market share gains.

-          EBITDA-Capex margins: Consistent with thesis point 3, we give credit to the company for the guided synergies.  

-          Spectrum: We have an annual assumption for spectrum purchases. While in practical terms, spectrum spending will be lumpy, given the timing uncertainty we decided to have an annual assumption.

-          FCF: FCF to reach $20.9bn by 2026 or around $21.9 per share as we expect the company to retire ~25% of shares outstanding between 2023 and 2026. Buyback prices start at $172 per share and reach $262 by 2026.

Risks and mitigants

Some of the risks below will be related to the bear arguments.

-          Deterioration of competitive environment led by T who is in a tough spot: There is a possibility that T decides that it needs to grow and keeps/expands its aggressive promotion strategy forcing VZ to respond and resulting in a downward spiral. In this scenario, EBITDA per sub (through either ARPU or net equipment margin) would suffer. In addition, it would be generally more difficult to add subs. We estimate that T’s mobility business has ~28% EBITDA-Capex margins in an average year, whereas VZ is likely at ~35%. That means there is margin to give up.

o    Mitigant: As previously mentioned, there is no silver bullet here. We think the probability is low, and if it happens TMUS should not be meaningfully impaired. There is a limit to how aggressive the carriers can be, given that really aggressive moves require for them to reprice most of their customer base. We discussed the impact of a 15% price decrease in the introduction. This means that there is a practical limit to what can be done and that is why competitors tend to focus on promotional activity with devices or third-party add-ons.

Furthermore, even if the competitive environment deteriorates materially, it is hard to come up with a scenario where TMUS is worth a lot less. With the small/rural market and business opportunities, TMUS has 16mm phone subs to gain, which means that the company can ‘give up’ close to another 16mm phone subs (or 18% of total phone subs) and be flat on a sub basis (assuming they don’t want to chase promotional activity). In addition, contextualizing this scenario would be valuable. The reason we are even considering this scenario is because TMUS is hurting T and VZ’s business. VZ and T’s position should be no more aggressive than to do as little as possible to stop market share losses. To us that scenario means that TMUS isn’t growing subs anymore, which is how we would book-end this risk. If it takes 3 years to get there, by 2024 TMUS would be earning just under $15 per share in FCF and would be at 2.2x Net Debt/EBITDA. At the current share price, the company would be valued at just under 10x FCF.

-          Even though the company has excess spectrum, it doesn’t mean that they won’t spend a lot of capital acquiring more: As covered on thesis point 2, TMUS does not need to acquire spectrum. However, because they do not need to, that does not mean they will not. Although TMUS is closely held and has a track record of shareholder-conscientious behavior, they may want to keep their self-proclaimed network advantage, which is not necessarily rational because they depend on other companies. If other companies are irrational, then they can force TMUS’ hand (which is arguably what happened to VZ in C-Band).

o    Mitigant: Here we are placing a degree of trust on management and the board. It helps that no one expects a large auction for some time. Their statements on network leadership can also be strategic, there is a lot of game theory that goes into spectrum auctions.

-          New entrants in cable: There is a risk that cable’s market share gains start accelerating. As the below pricing chart shows, CMCSA’s pricing is now in line with TMUS’ pricing on most number-of-lines combinations, and better than TMUS for one line. CHTR has the same MVNO with VZ so they can match CMCSA.

o    Mitigant: Despite cable’s impressive growth in wireless, they are still usually less than a third of industry net adds. Cable’s combined net adds in the upper 500k a quarter is less than TMUS’ in the 1mm+ range. It’s too difficult to know how successful cable will be in mobile. We are of the view that they will be successful but find it difficult to assign probabilities to a specific outcome. As a new entrant, they have a compelling value proposition, with aggressive pricing and well negotiated access to the VZ network. They also have strong distribution capabilities, which has been instrumental in their success. Furthermore, it’s still an MVNO and prices are aggressive but right in line with TMUS (except for single line pricing where cable is a lot cheaper). All this to say that it’s too hard to predict with a high degree of confidence.

Despite the difficulty assigning probabilities, we do know enough to put brackets around outcomes. The way we have thought about the risk is to construct scenarios we would describe as unreasonably positive for cable and see what happens in those scenarios. The way we constructed the analysis was by assuming that cable would capture the most available subs in the market. We define available subs as switcher pool + market growth. Our assumptions were such that cable’s mobile business was adding more subscribers than their broadband business (assuming 2.2 lines per household). Even through these assumptions, TMUS adds subs (cumulatively) in the next five years, with net adds accelerating as cable begins experiencing the impact of churn on a larger subscriber base.

For modeling purposes, in our TMUS net add projections, we assumed cable maintains its current net add pace. If we are off, the impact on our valuation should be limited as long as there isn’t a step function change in net adds from cable. In a scenario where cable adds 7.5mm more subscribers in mobile than we expect them to between 2021 and 2026 (for context their current combined sub count is 6.5mm), we estimate that it would cost TMUS around 1.6mm subs in the period and would lower our estimate of intrinsic value by 3%. We get there by assuming 1% market growth and that share losses are split equally between competitors.

-          New entrant in Dish: T may have given Dish a lifeline with the recently announced MVNO. The company was in a particularly tough situation and in a race against time, now they have a longer timeframe to execute their plan and a more willing provider to sell them capacity. Dish’s O-RAN network promises to decrease equipment costs, by both buying cheaper equipment (not having to pay a premium for integrated equipment) as well as less equipment (virtualized baseband pools serving multiple sites). Now there is even an argument that the company won’t necessarily have to build beyond their 2025 FCC pledge of 70% of the population as they have a partner that seems more willing to make Dish a viable business.

o Mitigant: Despite T’s lifeline, Dish still has a significant uphill battle. To start, the concept of an O-RAN network as Dish wants to build it is largely unproven. While there are potential cost savings on equipment, the company likely has an insurmountable disadvantage in both distribution (retail locations, equipment inventory, advertising, etc), and scale (they currently have 8.9mm subs). Boost mobile has been rapidly losing subs, losing 5.6% of their subscriber base in two quarters. In addition, a segment of Boost’s customer base will face disruption as TMUS shuts down its CDMA network and T doesn’t operate one. The customers exposed to this issue will be forced to change devices. Equipment isn’t the most capital-intensive component of building a network, we have seen estimates that handicap equipment costs at about 20% of the total costs of building a network.

Appendix

Exhibit 1: Wireless subscriber growth in the early 2000’s by company

Exhibit 2: Spectrum position for the three wireless carriers

Exhibit 3: Coverage studies across frequency bands (Source: Crown Castle)

Catalyst

Earnings.