Description

Buy TMUS.  

Summary

1)      The stock has plenty of upside (to ~$45+,  or 33% upside)  from both a fundamental perspective and possible M&A takeout

a.       I think it’s highly likely that DISH makes a bid for T-Mobile

                                                              i.      I think it’s a pretty high likelihood that TMUS isn’t a standalone company in the next few years (either DISH, Sprint, or some other random international mobile provider buys it)

                                                            ii.      Longer term, perhaps by 2016, Sprint will probably make another pass at TMUS (with a more receptive administration and regulatory environment)

                                                          iii.      DISH needs & wants to put their spectrum to work.  T-Mobile is their last option 

b.      Potential 33% upside from organic core growth at TMUS standalone

c.        Dish is running out of time (given network buildout requirements, and need to do something while their core payTV biz has value) and has a good opportunity to make an acquisition post the AWS spectrum auction, which has elevated their spectrum valuation

d.      On the downside, the stock recently bottomed at $25, which is 5.7x 2014 EBITDA, which is quite cheap and on the lower end with historical comps and trading ranges.  

                                                              i.      Around the high $20s, you could also make the argument that the asset value in the biz (subs, network, spectrum), provide a floor to valuation

1.      So maybe around 15% downside

                                                            ii.      It got to the high $20s back in December after S and Iliad bids have faded, during some of the wireless competition fears (and negative warnings from VZ), and a recent convert offering that they did

1.      Probably hard to see that trifecta of pressure again

DISH / M&A

2)      DISH’s stock is elevated now post the spectrum auctions, which showed the value of the spectrum that they've accumulated over the years

a.       For DISH, Charlie Ergen is sitting in a good spot right now.  His stock is up; telco merger mania has calmed down; and the future continues to point to over-the-top and mobile video offerings (which he wants to do)

                                                              i.      Ergen has been eager and prescient in solidifying a position in mobile video and over the top with his spectrum purchases and OTT content negotiations

                                                            ii.      His newest Sling offering has been pretty interesting / compelling 

                                                          iii.      I think DISH’s spectrum, content, subs, etc. could be very valuable to a wireless carrier

                                                          iv.      Some wonder, “What happens if DISH & TMUS merge, doesn’t the spectrum value disappear?”

1.      Yes and no.  I think spectrum asset value tends to ‘disappear’ when it is being used and generating revenues. 

a.       E.g. VZ, T, and TMUS don’t have excess spectrum and hence that value isn’t being separatetely valued

b.      But Sprint has excess spectrum and that is arguably why Sprint trades at a seemingly high multiple to its future EBITDA or earnings.  Indeed, Sprint has recently been looking to sell some of their excess 2.5 GHz spectrum and people are interested.   So clearly there is some value that can be monetized there

                                                                                                                                      i.      Leap and NIHD Mexico were also bought (both by AT&T) at prices that mostly reflected their spectrum value

c.       Hence, I think people will continue to assign value to the excess spectrum of a combined TMUS and DISH.  That value won't simply go away  

                                                                                                                                      i.      As has often been theorized, DISH could still license it or sell parts of it

                                                                                                                                    ii.      VZ is interested in it, as would AT&T (but T has enough on their plate right now) 

b.      DISH needs to get the ball rolling on its spectrum build out requirements.  Ergen is running out of time there

          i.       He likely has to start building out in the next few years to meet the coverage requirements

d.      T-Mobile’s major shareholder, Deutsche Telekom is a motivated seller

                                                              i.      They’ve accepted bids of $48 / share from AT&T back in 2011,  but that didn’t go through due to regulatory antitrust roadblocks at the DOJ and FCC

1.      TMUS subsequently got a break-up fee of $3bn of cash and $1bn worth of 700 MHz spectrum

                                                            ii.      They were willing to sell to Sprint for around $40 / share from Sprint in mid 2014 (for a mix of cash and stock)

1.      This also fell through due to regulatory headwinds.  The FCC was adamant about keeping the 4 player wireless market

2.      With Sprint and T-Mobile both spending, trying to attack the VZ/T duopoly, and making progress, it seemed logical for the FCC to keep the 4 player market.

3.      However, I do admit there’s some credence to Masayoshi Son’s argument that S and TMUS need to get together to be more meaningful competitor to the T and VZ duopolgy 

                                                          iii.      However, these bids were done before TMUS gained significant operating momentum and traction in sub growth, network improvements, coverage, marketing, brand equity, EBITDA, FCF, etc.

                                                          iv.      Iliad’s bid (French wireless operator)

1.      TMUS turned down the suspect Iliad bid for $33/share for a majority stake.

                                                            v.      Although less likely in my opinion, cable companies could also be interested

1.      Much has been speculated about Wi-Fi networks eventually taking some traffic away from cellular

2.      TMUS popularized Wi-Fi calling in one of its ‘uncarrier’ initiatives (although this was somewhat out of necessity because TMUS network coverage isn’t all that great, and promoting Wi-Fi calling certainly helps their perceived coverage).

a.       Wi-Fi calling and hand-offs are improving and the new iPhones support this feature

3.      This could certainly be an area where cable companies might want to partner with mobile carriers.  Although I think it's unlikely 

e.       So I think a bid of $45 is certainly very reasonable for TMUS shareholders and something that DT would accept 

Valuation

3)      T-Mobile is trading at a very reasonable & fair multiple of 6.2x EV/EBITDA on 2015 EBITDA of $7.5bn

a.       I think on a fundamental basis, I can see them continue to take share and grow EBITDA to $8.5mm in 2016,  at a 6.5x EV/EBITDA multiple (basically keeping the current multiple steady on consensus numbers), which gets to $45/share

                                                              i.      TMUS has continued to take share, and is on a path to 33-35% EBITDA margins (their medium term target), up from 25-30% now

                                                            ii.      T and VZ are more at 45-50% EBITDA margins on wireless.  Longer term, as long as T and S keep building out their network and catch up (since LTE levels the playing field and will be the technology standard for many years), then the overall margins differential should compress over time

                                                          iii.      Also, they have plenty of MetroPCS network and non-network synergies, which they’ve been executing on efficiently and on schedule

                                                          iv.      I estimate that TMUS will get to around ~14.5% postpaid phone share, up from 11% in 2013 and 12% now.   So not a huge stretch

b.      I think TMUS’ network momentum will continue

                                                              i.      If you look at their RootMetrics scores, TMUS continues to gain #1 positions (or #1 ties) in many markets (27 out of 125 metro markets).  As they keep building out their network, the quality differences will disappear, and their value proposition, brand, and pricing will help them add more customers

c.       I’m a bit higher than consensus:

                                                              i.      Consensus has them at  $7bn of EBITDA in 2015, so it’s trading at 6.6x 2015 cons. EV/EBITDA

                                                            ii.      VZ trades is 6.7x 2015 EV/EBITDA

                                                          iii.      T is at 6.4x

                                                          iv.      So it trades inline with peers, meanwhile TMUS is growing share much more rapidly with revs up teens / high-single-digit, and EBITDA up around teens /20%s over the last and next few years.  while the other telco guys are flat, and Sprint is still bleeding

                                                            v.      So TMUS’s valuation is at worst ‘fair’. 

1.      But more likely it’s cheap even on consensus numbers, given that they’re growing, while others are standing still, although the VZ and T dividends support those stocks.   There's clearly room for multiple expansion as well at TMUS.  at 7.1x 2016 EBITDA, I get to $50/share or 50% upside 

d.      They’re finally going to be FCF positive, and can quickly generate substantial FCF given the operating leverage in the biz

Management

4)      CEO, John Legere has done an amazing job revitalizing and turning around the company

a.       The brand and marketing has been quite effective, especially compared to the mess coming from Sprint (the goat commercials and “cut your bill in half”)

                                                              i.      BTW, if you look through the “cut your bill in half” it’s really not that great of a deal.  Many of Sprint’s current offerings are better than the “cut your bill in half” promotion – management readily admits it too.  But it makes for a good headline

b.      TMUS has plenty of room to improve their network as they build out their network, roll-out the low band spectrum (to get more coverage and signal strength), and offer more interesting ‘un-carrier’ initiatives (the free international roaming, music offerings, wi-fi calling, data stash, etc.) are all pretty attractive and even innovative.  They have their competition reacting and trying to catch up

                                                              i.      Their network engineers have been amazing.  They’ve built out and merged the MetroPCS network very efficiently and quickly.  Just compare their progress to Sprint’s network issues/progress over the last 3 years

Business / competitive environment

5)      The recent price competition is abating post a competitive Q4 holiday season, which was made even more competitive during a historic iPhone upgrade cycle.

a.       TMUS has said that they will halt pricing pressure

b.      AT&T and VZ are not incentivized to be overly aggressive

                                                              i.      They’re more incentivized to keep milking their cash cows and keep their subs

                                                            ii.      AT&T learned their lesson last year.  Re-pricing the base didn't help them much

                                                          iii.      AT&T clearly has their attention on other strategic initiatives (i.e. DirecTV and making a bigger push into Mexico and LatAm with their NIHD acquisition)

                                                          iv.      AT&T is also around 100% dividend payout ratio, which limits their financial flexibility to cut pricing.  Although that improves if the DTV merger closes 

                                                            v.      VZ continues to keep their premium product positioning, which has allowed them to be above the fray so far and keep their premium pricing 

c.       Sprint’s attempts will remain rather futile until

                                                              i.      Their network improves considerably (whether defined by Root Metrics, Ookla, etc. ) and their brand improves

                                                          iii.      I think a Sprint turnaround is at least 3 or 4 quarters away

1.      Look how long it took S to finally get a decent network up and running around Chicago. 

d.      I believe TMUS’ operating momentum will continue and the street is conservative in modeling subscriber additions during 2015 and beyond

                                                              i.      From a big picture perspective, as TMUS and Sprint get their networks in shape, the overall share and margins between the large 4 mobile carriers should even-out over time

                                                            ii.      Also, VZ and T are getting saturated from a spectrum & capacity standpoint, meaning that over time, as bandwidth demands keep increasing, that share should also shift back to TMUS and S

1.      T suffered from network congestion in 1H 2014,  which is partly why they had to be so aggressive in their network build-out last year and with the AWS spectrum auctions

2.      TMUS still has much un-used network capacity,  as does S

                                                          iii.      TMUS’ network build-out, particularly 700 MHz over 2015 and 2016, will vastly improve coverage, building penetration, and reliability

1.      TMUS has thus far been targeting large metropolitan cities and people who want to use a lot of data very quickly

2.      Their 700 MHz spectrum rollout (although it’s pretty small in bandwidth and not a total game changer) will still meaningfully expand their actual coverage closer to 300mm pops from 225-250mm pops

a.       If they simply get their fair share, that’ll easily exceed current sub growth and their guidance of 2.2-3.2mm postpaid branded subs net adds (and expectations of 3-4mm).  Meanwhile, they’ll likely continue taking share as well

3.      They’re only building out about 9mhz of spectrum in their top 25 major areas, so it’s not game changing, but helpful

4.      This will open up many customers who didn’t consider TMUS given lack of coverage in their suburban areas or lack of coverage during a commute.

5.      It’ll also enhance T-mobile's reliability and call scores (which have been meaningfully lacking)

6.      Management’s recent comments seem very positive and upbeat and their targets seem easy to beat

Concerns

6)      Risks / downside

a.       Wireless is a rather competitive industry right now, with TMUS shaking up the industry

                                                              i.      Mitigants: Sprint and TMUS are both targeting AT&T and VZ duopoly.  Not going after each other as much

1.      Many of S and TMUS’ marketing campaigns are targeted at taking T/VZ customers

                                                            ii.      The big 4, except for S, are likely to refrain from price competition at the moment

                                                          iii.      Sprint may continue to be aggressive, but their network quality continues to be poor

1.      Any subs that they acquire may simply churn rather quickly and further damage the brand/carriers reputation

2.      Sprint can’t be too aggressive with promotions because they’d be at risk of re-pricing their base.  Given their precarious balance sheet, it would be dangerous 

b.      DISH’s bid could be weak or not happen at all

                                                              i.      I’d argue that there’s not much acquisition premium built into TMUS’ stock valuation.  Of course, there is hope out there though

                                                            ii.      DISH’s bid will mostly be equity (they’re currently ~5x levered), so they’ll have to offer a large % of the pro forma company, or really pump up the case for a combined DISH/TMUS

1.      Although DISH still generates sizeable FCF, that would help T-mobiles FCF profile

                                                          iii.      The mobile video strategy that Ergen has long talked about could become a reality and he’s been coming up with an attractive OTT offering and getting the rights to make such a service a reality.  It could be an interesting differentiator at least in the short term for both DISH and TMUS

1.      The $20 Sling TV base package includes ESPN, ESPN2, Disney Channel, ABC Family, Food Network, HGTV, Travel Channel, TNT, CNN, TBS, Cartoon Network, Adult Swim, and the "best of Internet video" with Maker Studios. Add-on packs with additional kids and news programming will be available for $5 each.

a.       This is actually a pretty decent bundle and gets many of the key channels people care about.  Ergen was a visionary when he first launched Dish, and he continues to show his willingness to be innovative and transformative with what he's doing now.  He knows that one can't be worried about making one's legacy business obsolete 

2.      AT&T and VZ have been talking about it too; this is where the market is going.  Watching streaming on phones, tablets and laptops is next.  Interestingly, if TMUS and DISH got together, they'd have a massive mid-band portfolio, perfectly for this type of content and use case.   DISH and TMUS could even have enough spectrum and capacity to offer some sort of mobile broadband (Sprint is also in a position to do this with their CLWR spectrum).  You could get speeds of 75-100mbps (much faster than people's cable/FiOS).   It could be game changing.   I think this is the more exciting possibility for TMUS and DISH

                                                          iv.      DISH has no where else to go.  VZ doesn't want a satellite TV offering; AT&T has their hands full; Sprint doesn't need more spectrm and probably won't be allowed to buy more 

                                                            v.      T-Mobile's network is a good fit for DISH’s spectrum as well.  TMUS has similar frequency spectrum and hence rolling out DISH spectrum isn’t that hard

c.       Spectrum floor?

                                                              i.      Perhaps you could find a floor in spectrum value – although I don’t put much weight on this analysis

                                                            ii.      Basically TMUS EV equates to ~$1.80 MHz pop their 78 MHz covering 300mm pops, which compares very favorably to the recent AWS auctions 

d.      Possibly more spectrum acquisitions (particularly in the broadcast incentive auctions)?

                                                              i.      Admittedly, TMUS needs to buy more low-band spectrum in order to get more coverage (which could cost billions, but is fairly well telegraphed now though)

1.      As a reminder low band spectrum (i.e. 700 MHz and below) is good for coverage & building penetration, but not good for capacity.

2.      TMUS has a mostly 2 GHz+ AWS network, which is good for capacity and data, but not as good for coverage.

                                                            ii.      So far, TMUS has been a metropolitan city-focused carrier and roams on AT&T for many suburban and rural markets

                                                          iii.      However, the broadcast incentive auction (i.e. where the FCC is trying to get local TV stations to repackage their ~600mhz spectrum and sell it in an auction) is in the works

1.      This ‘broadcast incentive auction’ would also have favorable bidding rules to help get more spectrum to the TMUS and S (who need more low band), so TMUS probably won't have to overpay 

2.      T and VZ have the vast majority of low band spectrum, and large swaths of it, which is why their networks are so good (hence why they like to advertise their reliability and coverage,  meanwhile TMUS and Sprint try to advertise speed)

                                                          iv.      Given the slow progress of this auction, or lack thereof, I don’t think that the auction happens in the next few years

1.      This limits any possibility of another dilutive equity or debt offering

2.      Hopefully TMUS will be taken out or the stock will hit my price target before then

e.       Industry competition? will likely abate

                                                              i.      TMUS has said that they’ll stop for now

                                                            ii.      T and VZ are reactive, not proactive.  Just protecting their base

                                                          iii.      Sprint not a real threat yet, perhaps a worry into Q3/Q4 (when I think they'll make some more network progress) 

                                                          iv.      Tough to hedge with another carrier short since T and VZ have dividend downside protection

                                                            v.      Sprint trades rich; I don’t have a strong view, but I think that it’s a short, although their network should improve somewhat by year end.  Hard to tell if they’ll gain traction in the market / advertising

f.       EIP – equipment installment plans

                                                              i.      The shift to EIPs and away from large subsidies is mostly an accounting shift

                                                            ii.      Average billing per user is roughly the same before this whole shift in EIP plans

                                                          iii.      I think the separation of the handset cost from the wireless service cost makes sense.  It helps the customer realize how much they're really paying for the phone (a lot that is)

                                                          iv.      For TMUS, much of the initial working capital drain and EIP messiness in the accounting should clear up in 2015

                                                            v.      However, it does bring on more credit risk to T-Mobile.  But, T-Mobile so far has not been reaching down the credit spectrum to pick up subscribers.  On the other hand, Sprint has

Balance sheet

-          820mm shares at $33 = $27.1bn market cap

-          $19.6bn net debt

-          $46.7bn EV

Other tidbits

-          Deutsche Telekom owns about 64% of the equity, they’re free to sell

-          Historical M&A multiples in wireless have been around 7.7x EV/EBITDA, which gets to $46/share

T-Mobile history

-          DT bought VoiceStream wireless back in 2001 for $35bn and named in T-Mobile. 

o   Currently their stake is worth $24bn

o   They’ve been underwater on this and want to focus on their European assets

-          T-Mobile merged with MetroPCS in 2013 and become public that way

Catalyst

- M&A from DISH, Sprint, Iliad, cable, etc.

- Continued great operational momentum and execution

- More uncarrier initiatives

- Quarterly earnings:  I think they'll keep beating and expectations are low