Expect T-Mobile to Continue Inflicting Pain on Verizon and AT&T

 | Feb 14, 2017 | 9:07 PM EST
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With T-Mobile USA (TMUS)  having emphatically punched a hole in Verizon (VZ) and AT&T's (T)  assertion that the former's aggressive pricing would only win over low-end consumers and do nothing to keep them from seeing healthy wireless service revenue growth, the two largest U.S. mobile carriers have had little choice but to fight fire with fire, even if their margins and ARPUs took a hit. T-Mobile's latest numbers and guidance suggest the bleeding is far from over.

As pre-announced in early January, the self-proclaimed Un-Carrier added 2.1 million subscriptions in the seasonally strong fourth quarter, including 933,000 branded postpaid phone net adds and 541,000 branded prepaid net adds. With 8.2 million net adds recorded for the whole of 2016, T-Mobile's service revenue grew 11% annually in Q4 to $7.2 billion.

Total revenue, which also includes device sales, grew 10% to $10.2 billion, topping a $9.9 billion consensus analyst estimate. EPS of $0.45 was up from $0.34 a year ago, and topped a $0.28 consensus. Free cash flow (FCF), which can be lumpy from quarter to quarter, fell by $59 million to $743 million, but grew by $743 million during the full year to $1.4 billion. And despite T-Mobile's pricing strategy, branded postpaid phone ARPU was up 0.7% in Q4 to $48.37.

For 2017, T-Mobile currently expects to add 2.4 million to 3.4 million branded postpaid net adds. But the company offered the same guidance for 2016 a year ago, and wound up producing 4.1 million.

Separately, T-Mobile responded to Verizon's headline-grabbing Monday launch of unlimited data plans by addressing the two biggest complaints about the unlimited data plans it launched in October: A lack of 4G hotspot support and the fact only "DVD-quality" video streaming was supported. 10GB of monthly hotspot data is now included, and HD videos can be streamed.

With the company charging $70 per month for 1 unlimited line, $100 for 2 lines and $160 for 4 lines -- and with taxes and fees included as of January -- T-Mobile's unlimited pricing still undercuts that of its larger rivals. Not counting taxes/fees, Verizon charges $80 per month for 1 line, $140 for 3 and $180 for 4. AT&T, which launched an unlimited plan last month, charges $100 per month for 1 line and $50 for each additional line, while providing no hotspot data outside of smart cars and requiring users to sign up for one of its TV packages.

Smaller peer Sprint's (S)  pricing is more competitive. Not counting taxes/fees, it charges $55 per month for 1 line, $40 for a second line and $30 for each additional line. It also has a promo going under which lines 3 through 5 are free for a year. However, Sprint charges $20 per month extra per line for HD video streaming.

As in so many prior quarters, T-Mobile's top-line performance was easily better than that of its peers in Q4.

Verizon's wireless service revenue fell 4.9% annually, as price cuts and a slight decline in the prepaid base offset 2.3 million 2016 postpaid net adds.

AT&T's business wireless service revenue grew 4% in Q4 to $8 billion, but consumer wireless service revenue fell 6% to $6.7 billion. Ma Bell lost 1.5 million consumer wireless connections in 2016, which along with price pressure offset 2.4 million business postpaid adds and strong connected device growth.

Though it claims 1.7 million net adds (929,000 postpaid) for the first 9 months of fiscal 2016 (ends in March), Sprint's service revenue fell 5% in the December quarter to $6.3 billion, as its pricing strategy leads to postpaid ARPU declines. The company added 401,000 postpaid subs last quarter and 673,000 wholesale and affiliate subs, but this was partly offset by the loss of 501,000 prepaid subs.

Going forward, Sprint's financial situation leaves it in a tough spot, one where it's far from clear that the company can deliver positive cash flow while spending what's needed to keep its network competitive and maintaining the rock-bottom pricing it apparently needs to grow its postpaid base. Sprint only expects breakeven adjusted FCF -- it includes the proceeds from device financings and the sale of future lease receivables, minus repayments -- for fiscal 2016, in spite of having a full-year cash capital expenditure budget of just $2 billion to $2.3 billion.

And with $31 billion in net debt on its balance sheet, Sprint -- unlike its three main rivals -- declined to take part in the FCC's recent low-band spectrum auction. The auction offered both Sprint and T-Mobile the chance to obtain spectrum that could improve their rural and in-building coverage, which has been seen as a weakness for each, but only the latter took advantage.

T-Mobile, with its healthy FCF and stable ARPUs, was also comfortable spending $4.5 billion in cash capex last year. And it expects to spend $4.8 billion to $5.1 billion this year. While Verizon and (to a lesser extent) AT&T can still claim superior networks, T-Mobile is spending enough for large numbers of consumers to deem its network is "good enough" in light of its attractive pricing.

And that means the odds are high that the carrier will keep forcing Verizon and AT&T to choose between bleeding large numbers of postpaid consumer subs -- and just maybe a few business subs -- and continuing to backtrack from their premium pricing strategies.

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