T-Mobile Stock: Decent performance, but more work to do (NASDAQ: TMUS)

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T Movable (NASDAQ:TMUS) has a strong business case, recording revenue growth in the highly competitive, price-driven and mature telecom market. As such, I was able to calculate a compelling price hike via my valuation model. On the other hand, TMUS’ financial performance still needs to improve and the absence of dividend payments is regrettable. Accordingly, I would view TMUS as a reserve for investors who are focused on long equity positions for their portfolios.

TMUS has been successful in driving growth in the competitive telecommunications environment with its innovative profile in service delivery, bundled offers and network quality. As shown in Figure 1 below, in the second quarter of 2022, the company experienced 5% year-over-year subscription growth with a concurrent 8.5% reduction in churn and a 2.8% increase ARPU. This is an exceptional performance compared to its direct competitors such as AT&T (T) and Verizon (VZ), the other historical wireless players in the United States. The data for this comparison was collected from the companies’ quarterly reports. A selection of indicators is presented here in the best comparative approach to assess relative performance.

Comparable operating data for TMUS, VZ and T

Figure 1 – Selected operating data for TMUS, VZ and T (calculated by author)

In summary, Figure 1 shows that TMUS has demonstrated operational performance leadership in the wireless market. By combining the growth of its customer base, including the contested postpaid segment, with an increase in ARPU, the company has paved the way for a steady increase in revenue. Additionally, lower churn allows for increased margin, as retention reduces pressure on customer acquisition costs.

In order to achieve such results, TMUS uses a strategic approach to quality by focusing on the actual customer experience rather than network lab measurements. Initially, the concept of “non-operator” aims to promote transparency with a complete package that can include the provision of content and hardware upgrades. In addition, a well-managed network offers a good perception in terms of speed, availability and features. The performance of TMUS’ 5G network matches this perception. Additionally, the strategy appears to be paying off after integrating Sprint into TMUS operations, as Sprint had a different customer approach and friction could be expected with the merger (as seen in post-2020 churn levels).

Investors should note, however, that investing in the network is not free from risk. For a telecom operator, revenue growth could be driven by higher prices (unlikely in the unlimited plan scenario, meaning additional data consumption from enhanced services is already factored in) or new customers (a more feasible opportunity in the IoT space as cellular penetration is already very high in the US, but potentially with deterioration in total ARPU), while the shorter timeframe for generation transition drives faster technological obsolescence.

Business Performance

RoE and dupont distribution for the assessment of financial performance

Figure 2 – TMUS Financial Performance Highlights (Calculated by Author)

As noted, TMUS is doing its homework by increasing its revenue and improving its bottom line. On the other hand, a risk investors need to recognize is that overall financial performance still needs to improve as the company continues to grow. Figure 2 illustrates the low return on equity and provides the Dupont breakdown for performance evaluation. The margin has narrowed since its peak in 2017, when it reached just over 10%. This reduction may be seen as a contradiction in terms of the aforementioned ARPU and churn performance, but it represents additional cost pressures in a tough competitive environment.

For example, with the launch of HBO Max, its parent company T integrated it into its wireless offering to create market appeal for customers of other carriers. VZ then reacted by offering a bundle with Disney+ (DIS) and TMUS had to take a step by partnering with Netflix (NFLX). This then resulted for these operators in a direct subsidy to customers on video content, which had a bad effect on margins. Additionally, the decline in asset turnover performance is directly related to the merger with Sprint, which had weaker financial numbers on both P&L and balance sheet, and the increased investment needed to roll out 5G.

Corporate sustainability

business continuity and cash flow assessment indicators

Figure 3 – TMUS Corporate Sustainability Highlights (calculated by author)

Due to its financial performance, Figure 3 shows the Altman Z-Score level and Free Cash Flow figures. Again, improving financial performance drove the Altman Z-Score to the 1.4 level in 2018 (which is still considered risky). The most notable improvement is related to retained earnings, which fell from -23.1 BUSD in 2013 to one-tenth in 2022, signifying that the company is implementing improvements. After integrating Sprint, the score fell to around 1.3, underscoring the need for continued improvement in financial performance. At this level, the risk of failure is relevant.

In terms of cash generation, this was directly impacted by heavy investment levels. This reveals the risk of technological obsolescence of telecom investments as the generation cycle (3G, 4G, 5G, etc.) gets shorter. As cash is under pressure, it is important to remember that TMUS is not a dividend payer. This can be compared to the roughly 6% dividend yield of T and VZ. It seems unlikely that dividends will become a practice for TMUS in the near term.

Assessment model

My evaluation model consists of a Monte Carlo simulation with one thousand turns on the FCFF model, where inputs are set for centrality and dispersion. The advantage of this methodology is related to the treatment of the fair price as a probability distribution under normal conditions. Therefore, the probability that the fair value is greater than the current price of the price generated by the dividend discount model (if any) can be calculated.

Here are the most important assumptions used:

  • Growth of 3% in Nova Scotia, lower than current subscription growth of 5%, due to lower ARPU on IoT subscriptions and competitive response. 2% standard deviation to allow for continued abnormal growth.
  • Gross margin and SG&A of 60% and 24% of NS with low volatility, in line with historical trend.
  • Capex at 17% of turnover, a consequence of the migration to 5G. The standard deviation is set at 6%, which creates the possibility of significant variation in annual capital expenditure, as investment is concentrated at times of technological transition.
  • Historical beta of 0.6.

Fair value of assets

evaluation model results

Figure 4 – Results of the evaluation model (calculated by the author)

The fair value of TMUS is US$233.24. Moreover, the probability that the fair value will be higher than the current price is around 80%, which translates into upside potential for investors. The company does not pay dividends, so the return is comprised exclusively of price returns. Improving cash flow prospects and customer growth are the main drivers of the valuation.

Investors might view TMUS as a reserve, given the price potential and low beta offset by financial performance risks and the lack of dividends.

Maria D. Ervin