TMUS - T-Mobile: How U.S. Cellular's Spectrum Assets Can Boost Growth

2023-11-18 05:01:56 ET

Summary

• T-Mobile's lead in 5G and the availability of C-band spectrum frequencies through the acquisition of Sprint put it in a position of competitive strength.
• However, growth has been sluggish last year and estimates are worst for 2023.
• Thus, the potential acquisition of U.S. Cellular's spectrum assets to boost up its home broadband (fixed wireless) product could lead to a 7.7% increase in T-Mobile's revenue growth.
• I have a target stock price of $162.
• There are stock volatility risks till a deal is finalized.

In my thesis on United States Cellular (USM) in August where I valued the company at $5.67 billion , I had evoked the possibility of the company being acquired by either T-Mobile (TMUS), AT&T (T), or Verizon (VZ), or as part of a consortium of acquirers. This was after the wireless carrier started exploring strategic options or in other words offering its assets for sale.

Indeed, the strategic review process has attracted interest from America's top three telecom service providers, not to mention private equity.

Now, T-Mobile's revenue growth has stalled to -0.8% YoY in its last fiscal year ending in December 2022 and analysts estimate the topline to regress further as shown by the blue dotted part of the chart below to -1.9% .

Therefore, given the need to accelerate growth, the objective of this thesis is to show how U.S. Cellular's spectrum assets can help T-Mobile in this direction and I start by providing a picture of the competitive landscape.

5G Evolving from Cities to Rural Areas

First, according to test results by Ookla , both T-Mobile's median download and upload speeds for the third quarter of 2023 (Q3) are faster than either Verizon or AT&T. Moreover, the MNO or mobile network operator boasted the highest number of prepaid customers at the end of Q3, according to Fierce Wireless . For this purpose, it was the first to launch a nationwide 5G SA (Standalone) network in 2020 followed by carrier aggregation whereby multiple (5G) channels are combined to deliver increased speed and performance.

In addition to its lead on 5G, the merger with Sprint in 2020 proved crucial to gain access to C-band spectrum frequencies, some of which still have to be deployed . By initially concentrating its network building and marketing efforts on the most populous regions, it has been able to grow rapidly, but competitors have also invested heavily in acquiring spectrum from the FCC.

Now, from the return on investment perspective, it makes more sense to serve the top 100 markets which consists of the main metropolitan areas and cities where the population density is higher. Hence, by capitalizing on the same infrastructure (antennas and backhaul fiber links) to sign more contracts, better returns are obtained. However, T-Mobile faces intense competition in these markets as Verizon and AT&T are able to leverage their fiber offerings to propose bundled products.

On the other hand, rural areas that are relatively under-connected offer the pure-play MNO, a relatively more level playing field. For this matter, rural America, with about 140 million people and making up 40% of the nation's population constitutes a major market for T-Mobile where it aims to reach a penetration of 20% of households by end-2025.

However, with a 16.5% market share at the end of the first quarter and facing competition, progress is likely to be tedious. To this end, the white spots in the coverage map below show the regions where T-Mobile has no coverage and some of these are in the West like Idaho or Oregon. These are precisely some of the regions where U.S. Cellular has 4G LTE coverage as shown in the blue map below, signifying that its resources could be used for T-Mobile to expand to these areas.

How can U.S. Cellular's Asset can help

These resources include tower infrastructures, the IT network, and employees with the technical and marketing know-how, without forgetting the spectrum frequencies that make these all work together.

To this end, as I had detailed in my earlier article, U.S. Cellular's millimeter wave (MM wave) is suitable for T-Mobile given that it uses that frequency band and is already at an advanced deployment stage in FWA or fixed wireless access which makes it more likely that it will need a fresh infusion of spectrum. For investors, FWA is the technology that the company sells under the T-Mobile Home Internet brand, also referred to as 5G broadband.

The company serves over 4.2 million customers in this market and faces heavy competition not only from traditional cable providers like Comcast (CMCSA) or Charter Communications ( CHTR ) but also from Verizon's Home Internet . Moreover, Comcast's Xfinity has expanded its internet and TV offerings to include mobile services by using the Verizon network through an MVNO (mobile virtual network operator) agreement. Thus, as per its management , T-Mobile has only recently been able to reduce the churn rate or the pace at which customers were leaving it. In contrast, U.S. Cellular's FWA solution has been successful, and it has demonstrated 5G FWA capabilities, both with MM Wave and using mid-band spectrums.

Therefore, its spectrum assets could prove useful to T-Mobile whose CEO while talking about MM waves, seemed to be open to the idea of spending on related resources in view of his company's 5G broadband efforts.

In the words of Mike Sievert during Q3's earnings call on October 25:

We use millimeter waves pretty strategically in very dense places and so far that's a great use for it. I will say, as we said last time, so no change, that we remain open-minded to whether there are techniques that would allow us to deploy capital specifically for 5G broadband and make a great return for you".

Quantifying the Revenue Growth Potential

Still, acquiring U.S. Cellular all by itself, which I had valued at $5.67 billion (table below), would significantly weigh on T-Mobile's balance sheet. The reason is that it has cash of $5 billion and debt of $ 113.9 billion as of the end of its fiscal third quarter of 2023 and the current high-interest environment is not conducive to borrowing. Noteworthily, c ompetitors also have high debt levels, which favors the emergence of a consortium-led acquisition.

As such, the tower assets can go to private equity or to companies like Digital Bridge ((DRBG)) for around $1.56 billion. As for the spectrum, consisting of frequencies that have not yet been utilized, these could fetch $2.5 billion . Now, U.S. Cellular spent $1.5 billion for a C-Band auction in 2021, a frequency band that could be required by Verizon to drive its own fixed wireless (home broadband) efforts since it uses those frequencies.

Now, assuming that the rest, or $1 billion (2.5 - 1.5) goes to T-Mobile, then based on an average Sales to Capex ratio of 6.46 as per the table below, (or $6.46 generated out of every dollar spent on capital), we can expect revenues of $6.46 billion.

Now, assuming that the deal gets done in 2025, then adding $6.46 billion to the amount of $83.81 billion already estimated by analysts for that fiscal year, I obtain a figure of $90.27 billion, representing a 7.7% increase. Adding to the 3.81% YoY increase already forecasted for that year implies T-Mobile can potentially grow at 11.51% in 2025.

Pricing in this inorganic growth in the company's value, the 7.7% growth would lower the Price-to-sales of 2.03x to 1.87x (2.03 x 0.922) given the inverse Price and sales relationship. Conversely, by adjusting the current share price to reflect this 7.7% discount, I obtained a target of $158.85 (147.5 x 1.077). Now, with a momentum score of " B+ ", T-Mobile stock could benefit from a few additional percentage points (say 2.3%) getting added to the 7.7% as news related to a deal hit the market. This is the reason I have a Buy rating with a 10% upside or a stock price of $162.24.

Long Term Growth but Short Term Volatility

However, such revenue growth is conditional on different parties forming a consortium and agreeing on how to split U.S. Cellular's assets. For this matter, when previously asked whether he was open to such a deal, T-Mobile's CEO appeared instead to favor organic growth, namely by deploying the spectrum assets it had already acquired, with the last round costing $3.5 billion in 2022. However, when it comes to such deals, it is not only about one company really needing an asset but more about purchasing it so that competitors do not lay their hands on them and leapfrog in front.

In this respect, this thesis has shown that by acquiring U.S. Cellular's spectrum assets, T-Mobile could add to its revenue growth. Investors will note that I have considered fiscal year 2025 for an eventual acquisition. This is in view of the stringent regulatory framework that governs the telecom sector in this country which ultimately means that regulators may take time to approve an eventual deal. Remaining in the realm of regulations, the MNO has to respond to a number of questions from the FCC regarding the Mint Mobile acquisition for $1.3 billion, which could fetch up to 3 million customers.

Moreover, given its track record of acquisitions, it is possible for T-Mobile to scoop other assets like a chunk of U.S. Cellular's customer base, but this remains subject to an agreement among potential bidders. Consequently, this remains a longer-term upside, with the current price action showing that the stock has still to cross the resistance level of $149-$150 (chart below), and this, despite enjoying record free cash flow in Q3 at the end of October.

This shows that investors may be looking for clear signs of topline expansion for this stock with a high growth score of "A". Conversely, this means that in case of adverse news like a competitor making the acquisition all by itself, the stock should be volatile because of a potential revenue expansion opportunity. Finally, the target of $162 still remains a fair one as, whether it is through U.S. Cellular or Mint Mobile, T-Mobile has at least two avenues of inorganic growth to boost its topline in the future.

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