Description

Preface:   I pitched TMUS here two years ago in July 2020 (refer to that write-up for additional context on where we’ve been/come from), but the stock is still my largest and highest conviction position on the long side in TMT, it’s the right type of stock for this market environment, and there are some positive developments that continue to make it interesting from here.  And for what it’s worth, since the pitch in July 2020, the stock is up ~27% (beating the SPX and trouncing peers T/VZ), but I think there’s more to go (certainly on a relative basis to everything else) as we’re at an interesting juncture in the story/stock.

Summary:

T-Mobile (TMUS) used to be the best value wireless offering with an OK network, but in 5G, it is the best network with the best value.  It has a much better spectrum position in mid-band (which offers the best combo of speed and propagation) and is two years ahead of VZ/AT&T in deployment.  Based on synergies from Sprint and the dominant growth position, TMUS should do ~$15-20 in FCF per share annually beginning in ‘24.  Moreover, TMUS is somewhat like CHTR was a handful of years ago in the sense that it will soon be embarking on a massive capital return program of ~70pct+ of the free float (~$60bn+ buyback).  Catalysts include improved churn/net adds in 2H post completion of the Sprint integration and the buyback beginning soon thereafter (they are expected to be upgraded to IG by the ratings agencies in August which should signal a buyback announcement is imminent).   You can pick your FCF yield/multiple in this new world, but ~$15-20 of FCF per share at almost any reasonable level (~8-10pct) translates to a $150-200+ stock over next ~18 months.

Risks and Details:

The main ‘pushbacks’ on the stock are: 1) it is a consensus long, it’s ‘over-owned’, and it’s crowded, 2) what happens to the overall industry as we lap these elevated net adds from Covid, and 3) what about the increasing competition from cable companies and maybe even DISH.  Addressing them in order, I acknowledge it is now firmly a consensus long.  It’s also one the best performing TMT names in the S&P this year (up ~16% in a down market), so it kind of comes with the territory.  But I would argue there’s a bit of a ‘show me’ story that’s still not quite priced in (and rightfully so).  Specifically, the Company is finally poised to see FCF inflect from ~$7.5bn this year (management guided $7.2-7.6bn) to over $17bn+ in 2024 (~50%+ CAGR).  The Company guided to ’23 FCF of $13-14bn alone which is nearly a doubling from this year.  While this sounds heroic for a ‘sleepy’ telecom giant, the inflection really just represents the fruits of culminating the Sprint merger integration, consolidating towers and expenses, and finally getting the benefits of the merger (essentially benefiting from merger synergies and lapping merger integration cost one-timers).  This is about as ‘in the bag’ as it gets in terms of taking a bet on a FCF inflection, but given the magnitude of the growth, especially in a decelerating macro environment, in conjunction with the fact that telecom companies rarely turn into ‘accelerating FCF machines’, it’s not entirely surprising that some folks are skeptical. 

The other dynamic that is not ‘priced in’ is the flow dynamics associated with the buyback.  Management has reiterated its capital return plan for $60bn+ in buybacks over the next three years, and the authorization/start is almost certainly to be announced in 2H this year (potentially before or at the very least in conjunction with the 3Q call in November).  Given that Deutsche Telekom owns ~48% of the stock (and is not a seller into the buyback until it is firmly a majority owner at the earliest), the $60bn buyback represents ~70% of the ~$87bn of free float.  To further appreciate what this means, if TMUS buys ~$20bn of their stock per year, their buying alone would represent ~20% of average daily trading volume, each and every day!  And this buyback doesn’t abruptly just stop at $60bn either in a few years.  That’s just the initial plan.

The second element of the ‘pushback’ is around the potential for slowing industry growth as well as increased competition (cable companies and maybe DISH).  The industry had historically added ~6mm of net post paid wireless subscribers per year pre pandemic, but this shot up to ~9mm over Covid and folks are worried about the inevitable reversion.  These additional net adds came from a variety of places including younger age cohorts that began receiving cell phones earlier (safety and communication requirements), older cohorts that didn’t really use smartphones pre pandemic but were forced to figure out how to use UBER and Instacart, and some corporates that started issuing more communications devices for secure, remote work purposes.  There was also a continued shift from pre-paid to post-paid subscriptions.  And while we really haven’t seen it yet, it is likely that the industry will decelerate to more moderate net adds (though it’s also likely net adds will normalize above the ~6mm pre covid due to the persistence of some of these factors).  The nice thing is, regardless of how exactly this shakes out, management guidance ($15-20bn of FCF) is not predicated on the ‘above pace’ industry growth we’ve witnessed, and they’re confident in their plan regardless of a slowing overall industry ‘net add’ pool.  The reason for this, is that TMUS has four primary idiosyncratic ways that it can outgrow the industry:  1)  Rural/Small Markets + Enterprise/SMB.  TMUS has historically been underpenetrated in these two verticals (~10% in each of these categories vs 30%+ in larger consumer DMAs) and now that their 5G network has the requisite breadth of geographic coverage, they are seeing outsized growth as they get their ‘fair share’.  Enterprises had historically gone with one of the two legacy incumbents due to geographic coverage, but now TMUS’ network is both better in the 5G era, covers more POPs, and is cheaper.  2) Fixed Wireless.  TMUS is no longer just selling mobile connectivity, but they now sell in-home ‘fixed wireless’ broadband.  For $50 a month or ($30 a month if you are a Magenta Max subscriber), you can receive speeds that average ~100mbit+ (upwards of ~300mbit+).  And while this may not be faster than fiber or cable, it is certainly faster than DSL (for folks in more rural areas), and more than sufficient for vast majority of home internet use cases.  And the numbers have been speaking for themselves.  They’re currently at ~1mm of home broadband subscribers and are poised to add ~4-500k in 2Q of this year (on their way to a reiterated ~7-8mm target in ’25).  They added more broadband net adds in each of the last two quarters than any of the cable companies.  3) ‘High-end Consumer’ in large DMAs.  They have also been under-represented amongst higher earning demographics where the consumer focuses on quality/network speeds and is less price sensitive.  But TMUS now has an opportunity to win these customers as they alas have the best network in 5G (and the best value).  4) Sprint churn.  TMUS closed the Sprint transaction last year, but they have not yet fully migrated customers to a ‘T-Mobile’ experience.  Churn at TMUS is half of what it is for the legacy Sprint customers, and the Company has seen that when they fully migrate customers, the churn ends up nearly identical to that of a typical TMUS customer.  There is an additional ~300-500k+ of embedded net adds per quarter that could materialize as the migration finishes in 2H this year.  Finally, a word on competition and DISH.  The industry has always been competitive, but with 3 players today instead of the historical four (DISH doesn’t really count), there’s not a huge near-term risk of a worrisome promotional environment.  This has been showing up in the numbers with TMUS actually guiding ARPU up in recent quarters.  Moreover, TMUS has a bit of a pricing umbrella vs T/VZ and neither of those companies are looking to do anything to materially damage their margins (VZ is struggling as is).  With DISH, I don’t have a lot to say other than pointing people to the recent investor day they did (it was a joke and Charlie sounded terrible)…  And just look at the stock price.  It is going to be very hard and capital intensive for them to stand up a credible competing 5G network (it sounded like they’re more focused on the enterprise ‘edge compute’ use cases that are several years out from potentially being relevant).  Moreover, TMUS is providing the DISH MVNO so in effect, TMUS will be benefiting from any modicum of DISH success via the wholesale business.   

In summary, it is true that the industry may see decelerating growth, but TMUS has several unique opportunities to continue to grow regardless.  And while it is a ‘consensus long’, the stock should continue to ‘re-rate’ higher as 1) the projected FCF actually materializes into ’23 and ’24 with Sprint integration completed, and 2) the $60bn+ buyback materially shrinks the share count.  Lastly, as we all face the prospect of a potential recession at some point in the not too distant future, TMUS is one of the most defensive types of stocks/businesses going into a slowdown.  Some joke (though it’s likely true) that people will stop paying their mortgages before they stop paying their cellphone bill. 

Catalyst

Credit rating upgrade to IG (potentially August), buyback authorization/announcement, actual buyback, FCF inflection in '23