Description

T-Mobile (“TMUS” or “the Company”) is a wireless phone carrier that is now the #2 carrier in terms of post-paid phone subscribers (~67mm vs ~63mm at AT&T and ~90mm at Verizon) after its April 1^st (shockingly not any April fool’s joke) combination with Sprint.  At ~$106, the pro forma company has a ~$132bn market cap and ~$195bn enterprise value (~$63bn of net debt).  Despite the run-up since the close of the transaction, the stock is still interesting as the transformational merger offers an asymmetric risk-reward profile over the next ~6-24 months.  The key tenants of the investment thesis are: 1) cost synergies of $6bn+ (on a PF 2019 base of ~$23.3bn) that will be larger and be realized quicker than guided, 2) improved spectrum portfolio that will allow the Company to create a 5G network that’s better than VZ/T while continuing to have industry leading port ratios/net adds, 3) improved industry dynamics with less competition that will allow TMUS to continue to expand margins as synergies roll-on, 4) an unmatched customer value proposition with prices ~10-20% lower than peers with an on-par/better network, 5) secular tailwinds around internet connectivity/mobility, IOT devices, and fixed-wireless broadband that are not captured in estimates, 6) an increased investor base as float is increased post the Softbank transaction and long-only money moves into the name which has been in ‘M&A purgatory’ for the last three years, 7) modest estimates that seem quite achievable as synergies are bigger/faster, 8) a defensive business model that will generally do well if we end up in a protracted downturn, and 9) a reasonable valuation pro forma for the synergies.  To put some simplistic numbers around this last point, the combined business did ~$23.3bn of EBITDA last year and will have ~$30bn of EBITDA in a few years assuming minimal growth and the ~$6bn of guided cost synergies.  At ~7-8x ~$30bn of PF EBITDA, the stock would be worth $120-145 representing ~15-35%+ upside over the next two years in a very defensive asset that has limited downside in an onerous/unlikely scenario which assumes almost no improvement from 2019 (~7x ~$24bn of EBITDA would leave you with an ~$85 stock or ~20% down). 

New T-Mobile has guided to $4 billion in network synergies (about 93% of that $4b of annual synergies coming from operating expenses, and the remainder from capex), and $2billion from SG&A.  The majority of these saves come from eliminating the need to run duplicative networks and shutting down some ~50% of Sprint’s cell sites.  Adding these guided synergies results in a ~44% EBITDA margin, far lower than peers of similar size (~55% service revenue margins at AT&T and ~66% service revenue margins at Verizon), so significant upside to estimates over time is certainly plausible.  The opportunity to exceed this initial guidance was alluded to following the May earnings release when management spoke with CNBC, noting "optimism about the potential to go faster than we were expecting and potentially to go bigger than we were expecting on both growth and synergy attainment" with the company still targeting long-term EBITDA margins in the mid-50% range.  Further, management commented at the JPM TMC conference that the “MetroPCS playbook was a good guide for the current integration” (synergies in that deal came in 50% higher and 1/3 faster than initially planned).

In terms of network quality/spectrum portfolio and 5G strategy, we believe TMUS ‘layer cake’ approach to 5G is ultimately going to prove successful.  This approach uses low band (600mhz) for rural deployment, mid-band (2.5ghz and the like) for cities, and mmWave (>6ghz) for dense urban areas.  As it stands today, TMUS has ~309mhz of spectrum across the low/mid-bands which compares favorably to AT&T and Verizon with just ~164mhz and ~112mhz respectively.  TMUS also has adequate mmWave spectrum with 1,100mhz which compares to ~1,000mhz at AT&T and ~2,000mhz at Verizon.  In summary, TMUS has a substantially better spectrum portfolio across the board compared to AT&T and meaningful advantage versus Verizon in the low/mid-bands (which is necessary to bring 5G to the majority of the country).  Verizon has emphasized mmWave as the core part of its 5G strategy but this spectrum will ultimately need to be bolstered by low/mid bands with better propagation to serve customers outside of urban centers.  To that end, TMUS will quickly double the speeds of the current LTE networks in rural areas with rapid deployment of its 600mhz spectrum, and the Company has promised to offer average 5G speeds in excess of 100mbit/second across 90% of the US population in six years. 

Beyond the upside related to an improved cost base and the potential for improved churn/net add metrics as the vast spectrum portfolio is deployed, TMUS also has additional upside from additional 5G IOT devices as well as fixed wireless broadband.  The company already offers a fixed wireless product for $50/month to serve rural areas, but will ultimately be able to serve over half the US population with 100mbit fixed wireless service by 2024. 

In terms of risks, competition from cable companies utilizing MVNO agreements (Comcast, Charter, Altice) is one potential source of disruption.  Additionally, DISH may ultimately try to deploy a ‘cloud-based’ wireless architecture modeled after Rakuten’s in Japan that could offer high speed wireless at a fraction of the cost of T-mobiles infrastructure.  While we acknowledge this is something to watch, we gain comfort with the fact that TMUS currently offers the best value proposition in the industry (~10-20% cheaper on average before including some of the additional perks like free Netflix) and any impact from a successful fourth carrier launch by DISH will be 5+ years out.  Management changes (CEO, CFO) would be another potential risk as former CEO John Legere has passed the baton to Mike Sievert (formerly the President and COO), though we see this disruption as minimal given Sievert has already been overseeing operations for a number of years.  Finally, while we believe upside to synergies is likely (and perhaps will be revised higher on the next earnings call), there is a risk that integration/execution goes worse than planned.

In summary, an investment in T-Mobile represents an asymmetric opportunity to own an asset that is benefitting from secular trends (5G, mobile connectivity), is critical in a post COVID world, has embedded upside to margins via substantial cost synergies, is largely under-owned by the long-only investment community (historically low float and merger dynamics), has upside to modest street estimates, and is trading at a very reasonable PF valuation a few years out (<7x EBITDA vs the larger incumbents at ~7x+).  The stock at ~$106 has ~$20-40+ of upside if management executes and just ~$15-20 of downside in a pretty anemic scenario while also being a very defensive asset in an otherwise stretched equity market. 

Catalyst

·         Uncarrier Event – July 16th – ‘What’s next for PF company’

·         PF Guidance on next call (PF financials, synergy updates, street estimates revised higher)

·         Increased investor base given the closed merger and post Softbank transaction increases float

·         New T-Mobile branded launch later this summer (Spring rebrand)

·         Quarterly earnings (execution/timing of synergies, sprint churn reduction, 5G roll out - fixed wireless and IOT)