Typically I am a dividend-minded investor, but there are some times when dividend-paying companies are at a serious disadvantage within an industry. Such is the situation, I believe, with telecom companies in the United States. Listening to the quarterly conference calls of the telecom giants in the U.S., it is becoming harder and harder to deny that this is an industry in flux.
It is true that the lines between entertainment and communication are blurring, but it’s more than just that. All content is moving to the mobile internet, and telecommunications carriers are ultimately going to be responsible for facilitating the spectrum and infrastructure to transmit all that.
Because the internet was built for unlimited access to data, it will be difficult for both carriers and content providers to put a unit price on data or content like they have with cable TV or traditional telecommunication. If there is a limit to how much data consumers want, we have not hit it yet. Data traffic continues to grow across the country as more and more consumers switch to 4G and 5G devices. The need for data infrastructure should rise subsequently.
If the telecom industry were still a “slap-happy oligopoly,” to borrow a phrase from Jim Cramer, then maybe the telecom carriers could go on business as usual. However, T-Mobile US Inc (NASDAQ:TMUS), a spinoff formerly Deutsche Telekom’s US cellular division, has proven to be quite the disruptor. In the first quarter of this year T-Mobile has effectively forced both AT&T (NYSE:T) and Verizon (NYSE:VZ) to capitulate and offer unlimited data plans, something both said they wouldn’t do, and that’s just the tip of the iceberg. T-Mobile is taking share from the carriers and then some.
Transforming the industry
In a nutshell, T-Mobile is transforming this industry by forcing the other carriers to offer unlimited access to mobile data, and at a flat monthly rate with adequate bandwidth to meet an ever-growing demand. Until 2021, mobile data traffic is expected to grow by 35% compounded annually.
Unlike most other competitors, T-Mobile’s network was built for unlimited use at a good speed, and their low simple rates are attracting an unprecedented number of customers who are frustrated with the other carriers.
The results come thought pretty clearly. Last quarter T-Mobile added 1.1 million post-paid smartphones, marking four consecutive years of over 1 million net adds each quarter. The other big carriers would kill to have that type of growth. Service revenue also increased another 11%, as did overall revenue.
T-Mobile has built up its network to the point where it is comparable in speed and reliability to even Verizon. I believe that, once most users switch to unlimited, T-Mobile’s network might even be better than Verizon’s over time, because T-Mobile’s network was specifically built for unlimited use customer plans. Just this quarter T-Mobile won about 45% of all new spectrum auctioned off by the government, a move which bodes very well for T-Mobile’s network in the years ahead.
Despite being a smaller company with fewer financial resources at its disposal than its competitors, T-Mobile is able to rapidly build out its network like it has because it does not pay out a dividend, which makes the company much more financially nimble.
For example, over the last twelve months Verizon generated $22 billion in operating cash flow, $17.5 billion had to go to capital expenditure, leaving only $5.1 billion in free cash flow, but the company’s $9.2 billion dividend obligation means that Verizon has to take out debt and lean on its balance sheet to fulfill its capex obligations.
T-Mobile, on the other hand, generated $6.1 billion in operating cash flow, and capital expenditure was $8.67 billion, leaving the company a
“funding gap” of $2.5 billion, even though last quarter T-Mobile did generate some free cash flow. The point is, the huge dividend commitments on both Verizon and AT&T are serious handicaps in a time where a lot of capital investment is going to be needed to meet ever-growing data needs. T-Mobile’s relative financial flexibility is part of the reason why T-Mobile has been able to disrupt the US telecom industry like it has over the last few years.
Buy the disruptor
Telecom in the U.S. is changing rapidly, but I believe this change is a lot more simple then what some are making it out to be. Cable and wireless are converging onto the mobile internet. Ultimately that means telecoms will soon be providers of unlimited internet access at a flat monthly rate. Other telecoms still don’t have the desire to be that, but in the words of CEO John Legere, “they’re going to have to swallow it.”
Simple as that may be, it is in that radical simplicity that T-Mobile is able become increasingly efficient as a company, particularly at the installation and customer service level. By 2019 T-Mobile hopes to cut call center calls in half, and set up service in half the time per customer.
Courtesy of Google Finance.
There’s no doubt at all that shares of T-Mobile are pretty expensive, and it’s been going higher over the last twelve months especially. However, of all the major telecoms in the U.S., T-Mobile is the one that “gets it,” and is the best suited for the future. And that future actually looks pretty good because the demand for mobile data only continues to grow.
For its part, T-Mobile is profitable and plans to become more and more so. Net income grew 46% year-on-year in the last quarter, and T-Mobile posted free cash flow (that is, operating cash flow minus capital expenditure) of $185 million. Management expects 45% compound annual growth in free cash flow up until 2019, with 15%-18% compound annual growth in operating cash flow until the same time. Increased cash flow could result in buybacks or possibly deleveraging.
I would not expect a dividend anytime soon, but there seems to be a lot of growth ahead. People are going to increasingly turn to T-Mobile, and as need for mobile data increases the company’s revenue is only going to grow. T-Mobile is the disruptive business in an industry which has a big secular tailwind behind it. For this reason, I consider T-Mobile a buy despite the runup in share price and lack of a dividend.
T-Mobile is forcing the U.S. telecom industry to turn a new leaf. For some this change will be painful, but investing in T-Mobile is a good way to embrace that change. If you’re interested in T-Mobile US, feel free to follow me here on Seeking Alpha. I intend to follow this company more closely in the future, and I will write update articles when doing so is both material and relevant.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.