Value Investors Club / T-MOBILE US INC (TMUS)

Description

TMUS equity is either going to work or not work over the next 3-4 years. If it works, I see 100%+ upside. If it doesn't work, I see -35% downside, but I think you can more than offset the downside with puts on VZ without materially killing your upside.

With the Old T-Mobile/MetroPCS merger and the AT&T/Leap acquisition, the wireless industry has consolidated down to four large carriers (VZ, T, S, and TMUS) and two majors (VZ and T). Wireless is a bad industry that has gone ex-growth with ~100% penetration and earns a low ROIC. On its face, it appears to be an oligopoly--even a duopoly--but still hasn't made decent returns even when excluding goodwill. Wireless is a simple high operating leverage business where you expend capex for a fixed cost base of towers and spectrum to create a network for which you have low marginal costs of selling a commodity product to each additional subscriber who brings high incremental margins.

A reasonable sounding answer to explain why the wireless industry is bad is that, unlike other cable and telecom, wireless customers in the US have more offerings to choose from. The number of competitors in a typical market is ~5-6, comprised of the big four national carriers plus one or two regional carriers. Contrast that with broadband at ~2 (cable plus dsl/fiber), video at ~3-4 (cable, two satellite, and fiber), and voice at 2 (telco and cable).

One reasonable thought is that the recent consolidation will lead to improving returns for the wireless industry. The major wireless carriers obviously have the scale advantage to fund proportionately larger spectrum spending that will only further seperate them from S and TMUS. Even with earning ~80% of the industry's EBITDA and ~85% of its EBITDA-Capex, VZ and T have barely earned their cost of capital. There is an expectation that the US wireless industry will convert to a duopoly that will experience expanding free cash flows. I actually think that the majors will never realize on the 'duopoly dream' for three reasons.

First, S and TMUS are quite transparent about their intentions to lead pricing wars.

http://bits.blogs.nytimes.com/2013/07/18/softbank-chief-hints-at-more-price-cuts-for-sprint/

http://www.businessweek.com/articles/2013-10-31/t-mobiles-john-legere-trashes-the-wireless-business-model

Softbank is attempting to run its Japanese playbook in the US through S. In Japan, Softbank bought the #3 wireless provider, invested in building the most technologically advanced network, spent heavily on marketing, and offered better pricing for higher levels of usage. TMUS is attempting to (a) take equipment margins down to zero and (b) highlight service pricing differences by eliminating the equipment subsidy within service rates.

Second, the DOJ/FCC are telegraphing an attempt to take away the spectrum-spending advantage that VZ and T have built through size.

http://thehill.com/blogs/hillicon-valley/technology/293663-justice-fcc-should-help-sprint-t-mobile-buy-frequencies

In a speech at Ohio State last week ,FCC Chairman Tom Wheeler said, "A key goal of our spectrum allocation efforts is ensuring that multiple carriers have access to airwaves needed to operate their networks. The importance of such competition was reinforced by a filing with the Commission from the Antitrust Division of the Department of Justice last April." For the last several years, the FCC has pointedly refused to say that the wireless industry is competitive in an annual report that the FCC makes to Congress.

Third, if TMUS equity does not ultimately realize its 'lower pricing --> market share gains --> high incremental margins --> expanding EBITDA margins + flat capital --> expanding ROIC' strategy, then TMUS and S will have left the wireless industry ruined for VZ and T.

TMUS has already moved to zero-margin equipment sales with its installment plan. There is a great note by Guggenheim from May 3 that attempts to seperate the VZ's equipment-subsidy out of its service revenue (~$11 out of $56 ARPU in 2012 belongs to equipment subsidy recovery fees). This would be an apples-to-apples analysis with where TMUS is trying to move the industry. Spoiler alert: if TMUS's zero-margin equipment sales become the industry standard, there goes ~11% of VZ's EBITDA.

Verizon (2012)	Reported	Economic	TMUS
	Version	Version	Vision
Service EBITDA	$38,500	$26,510	$26,510
Equipment EBITDA	(8,772)	3,218	–
Total	$29,728	$29,728	$26,510

For 2012, that would have been ~$3,218mm. Taxing that at VZ's 35% statutory rate means ~$2,091mm of after-tax income disappears. Poof! That compares unfavorably to $10,557mm of net income in 2012 for VZ. If TMUS/S are successful in obtaining any significant market share gains, they will come at the expect of VZ/T. Those market share losses will be of customers with extremely high incremental margins, showing the downside of the high operating leverage industry.

The T-Mobile/MetroPCS deal logic is part of the industry consolidation race and is based on the thesis of realizing cost savings by decommissioning the MetroPCS network and moving subs to the T-Mobile network through the natural equipment upgrade cycle. The merged entity faces a marginally better competitive position against the VZ/T duopoly. TMUS is the fourth-largest wireless carrier in the US and the smallest of the 'national carriers.' The thesis behind the TMUS merger is based on realizing cost synergies lowering the fixed costs of the merged entity and excess of unused spectrum and a network of redundant cell sites. A simple way of looking at it is taking the combined EBITDA and capex for 2012 disclosed by TMUS ("2012 combined entity results would have reflected $24.8 billion of revenue, $6.4 billion of adjusted EBITDA, $3.7 billion of capital expenditures (excluding spectrum purchases), and $2.7 billion of EBITDA-Capex") and layering on the run-rate synergies. This implies that TMUS is trading at ~11.5x Levered FCF.

MetroPCS EBITDA (2012)		$4,886.0
Old T-Mobile EBITDA (2012)		1,512.0
Total EBITDA (2012)		$6,398.0
Capex (2012)		(3,700.0)
EBITDA-Capex		$2,698.0
EBITDA Synergies		900.0
Capex Synergies		475.0
PF EBITDA-Capex		$4,073.0
Taxes	35.0%	(944.3)
Unlevered FCF		$3,128.7

PF EBITDA-Capex		$4,073.0
PF Interest Expense		(1,214.5)
Pre-Tax Income		$2,858.5
Taxes	35.0%	(1,000.5)
Levered FCF		$1,858.0
Shares		801.0
LFCF Per Share		$2.32

EV / EBITDA		5.0x
EV / EBITDA-Capex		9.0x
EV / Unlevered FCF		11.8x
P / Levered FCF		11.4x

I am using a couple of scenarios: High = 2017F straight from the merger proxy; Mid = 2013F EBITDA flatlined plus full synergies; Low = declining revenues (~8% CAGR) and flat margins.

(US$ in millions, except per share data)		TMUS
Share Price		$26.50
Shares Out		801
Market Cap		$21,239
DT Notes Held		5,600.0
DT Notes Resold		5,600.0
$500mm DT Revolver		–
Existing MetroPCS Debt		2,000.0
New MetroPCS Debt		3,500.0
Aug 2013 Debt Issuance		500.0
Nov 2013 Debt Issuance		2,000.0
T-Mobile Tower Lease Obligation		2,500.0
MetroPCS Capital Leases		356.0
Future Spectrum Purchases		2,000.0
Reported Cash		(2,365.0)
Cash from Nov 2013 Equity Raise		(2,000.0)
Cash from Nov 2013 Debt Issuance		(2,000.0)
PV of NOLs		(2,100.0)
Enterprise Value		$36,829.7

	Low	Base	High
MetroPCS EBITDA	$888.5	$1,300.0	$1,920.0
Old T-Mobile EBITDA	3,263.7	4,809.0	6,447.0
Synergies	1,375.0	1,375.0	1,375.0
NewCo EBITDA+Synergies	$5,527.2	$7,484.0	$9,742.0
Fair Multiple	5.0x	5.0x	6.0x
EV	$27,636.1	$37,420.0	$58,452.0
Net (Debt)/Cash	(15,591.0)	(15,591.0)	(15,591.0)
Equity Value	$12,045.1	$21,829.0	$42,861.0
Shares	801	817	864
2016 Value Per Share	$15.04	$26.72	$49.59
Cash Build Per Share	$2.25	$4.50	$7.25
Equity Value Per Share	$17.29	$31.22	$56.84
Current Share Price	$26.50	$26.50	$26.50
Upside/(Downside)	(34.8%)	17.8%	114.5%

Debt / EBITDA	4.0x	2.9x	2.3x
Net Debt / EBITDA	2.8x	2.1x	1.6x

EBITDA	$4,152.2	$7,009.0	$9,267.0
EBITDA-Capex	1,389.2	4,246.0	6,504.0
Unlevered FCF	903.0	2,759.9	4,227.6
Levered FCF	94.0	1,950.9	3,418.6
Levered FCF Per Share	$0.12	$2.39	$3.96

EV / EBITDA	8.9x	5.3x	4.0x
EV / EBITDA-Capex	26.5x	8.7x	5.7x
EV / Unlevered FCF	40.8x	13.3x	8.7x
P / Levered FCF	225.9x	11.1x	6.7x

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

Net adds by carrier

Spectrum auctions

Decreasing industry ARPU

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			2013	2014
Price:	26.50	EPS	$0.00	$0.00
Shares Out. (in M):	802	P/E	0.0x	0.0x
Market Cap (in $M):	21,239	P/FCF	0.0x	0.0x
Net Debt (in $M):	15,691	EBIT	0	0
TEV (in $M):	36,829	TEV/EBIT	0.0x	0.0x