Krause Fund Research Fall 2018

Transcription

1 Krause Fund Research Fall 2018 T-Mobile (TMUS) Communication Services Industry Jackson Hardie Analysts William Heatherington Stock Price vs. S.P 500 Investment Thesis Bull Outlook T-Mobile s Un-carrier market strategy breaks industry norms by focusing on the flexibility of phone plans, offering competitive pricing and providing outstanding customer service. The third quarter marks the 22 nd consecutive quarter T-Mobile has added a million net subscribers; Also, the 19 th consecutive quarter leading the industry in subscriber growth. This shows a promising trend that is expected to continue in the short term. The company experienced its lowest quarter 3 postpaid churn rate of 1.02%, continuing along its historic trend. Our short term economic outlook supports T-Mobile s growth story. Historically low unemployment, increasing wages, and a nearly 8 year record high consumer confidence will help bolster revenues and add subscribers. Bear Outlook T-Mobile s financial size and lack of technological advancements may put it at a disadvantage when trying to scale their 5G network to compete with Verizon and AT&T. Due to T-Mobile s high postpaid subscriber growth, it will be challenging to sustain their decreasing trend in churn rates as they approach the subscriber size of Verizon and AT&T. If ARPU continues to decrease, T-Mobile s increasing loss on equipment revenues will further increase the negative margins. November 5, 2018 Current Price $68.09 Target Price $82.00 $85.00 Stock Rating: BUY DCF / EP $82.95 P/E 2018 $42.27 EV / EBITDA $49.86 Stock Performance Highlights 52 Week Range: Beta Value: Share Highlights Market Cap: Bn EPS Quarter 3: $0.93 Company Performance Q3 Churn Rate: 1.02% Market Share: 17.4% Subscriber Net Additions: 1.6MM Company Description T-Mobile, is the third largest company in the telecommunication industry. T- Mobile is a wireless carrier who offers inexpensive pricing options for its customers. This company has been an industry leader by having the lowest churn rate for the past 16 quarters. T- Mobile does not only provide competitive pricing but offers customer service to retain the customers it brings in. For the quarter 3, total revenues rose 10.7% to $5.551 billion. Overall, we still believe T-Mobile s growth story will be sustained during our forecast period. As the industry transitions into the 5G network, we believe that T-Mobile is well positioned to compete with Verizon and AT&T. T- Mobile s Un-carrier plan has consistently led to industry leading subscriber additions and we have no reason to believe this trend will decline.

2 Executive Summary We believe that T-Mobile represents a good investment opportunity. It is currently finding significant growth in a very saturated industry. By marketing itself as the disrupter, it has displayed itself as the provider that will do away with customer dissatisfaction and phone plans that unjustly take advantage of the consumer. As a result, T-Mobile has instituted many strategies such as diverse and flexible phone plans, customer service improvements, and network coverage enlargements to focus on the customer. As 5G steadily becomes the focus of the industry, we believe that T-Mobile is positioned well to take advantage of the changing landscape and to become a front runner in integrating the new technology into their existing network. When combined with their positive subscriber growth and image, we place a buy recommendation on T-Mobile. Economic Analysis U.S. Real Gross Domestic Product Real gross domestic product (GDP) is the market value of all final goods and services produced within a country during a specified period of time. It can be broken down into four parts which includes: consumer spending, government purchases, investments, and net exports. Consumer spending constitutes approximately two thirds of real GDP, making it one of the most important variables 1. Currently, a growth rate of 4.2% in the second quarter marks the strongest year over year quarter growth in nearly 4 years 1. The first estimate for the third quarter comes in at 3.5% with further estimates to follow 2. In the next 6 months, we expect GDP to achieve an annual year over year growth rate of 3.3%. Consumer demand has continued to remain strong due to the tax cuts earlier this year, wage growth has been steady, and the unemployment rate has heavily declined. In addition, the reduction in the effective corporate tax rate has left companies with more cash to spend in various areas such as increasing the number of jobs or investing in capital intensive assets. In the long-term, we project a rate of 2.4% due to the likelihood of the bull run coming to a close. Because the Communication Services industry is relatively limited in sensitivity to the economic cycle, T-Mobile will slightly under-perform in the short-term and slightly over-perform in the long-term based on our real GDP estimates. T-Mobile s postpaid and prepaid phone revenue will likely weaken slowly over time as consumer spending decreases. Customers will focus on receiving the most for their money but T-Mobile s aggressive pricing plans may help it continue its industry leading net subscriber additions. As long as margins do not unexpectedly fall to unsustainable levels, we see T-Mobile as having a slight advantage over other competitors in the long-term. Unemployment Rate / Wages The unemployment rate measures the number of people unemployed as a percentage of the labor force. Wages are simply the measure of pay across the United States. Recently, the October unemployment rate remained steady from the month before at 3.7% 4. This is the lowest jobless rate in the United States since December, For wages, the third quarter showed an even greater increase of 3.3% as compared to 2.0% growth in the second quarter 5. Source: Statista 3 Sources: Federal Reserve Bank of Atlanta 6, Bureau of Labor Statistics 7 1

3 Strong corporate earnings boosted by tax cuts is reason enough for us to set a 3.7% unemployment rate target within the next six months. In the longterm, the declining slack in the labor market should spur upward pressure on wages, driving labor costs higher and returning the unemployment rate to a 4.5% level. In the short-term, these low unemployment rates are very good for the industry. Those that may have been prepaid users living on very small salaries will now be able to possibly upgrade plans due to their jobs. As can be seen in the chart above, low unemployment rates have spurred wage growth, causing upward pressure on total revenues for T- Mobile. In the long-term, increased wages in the midst of an increased unemployment rate will still be positive for the industry. T-Mobile will likely see consumers pursuing phone upgrades because of their increased disposable income. Also, they may upgrade to more expensive phone plans, boosting ARPU for prepaid and postpaid subscribers. Inflation / Interest Rates The inflation rate is the measure of purchasing power of a currency while interest rates represent the cost of borrowing money from an entity. The Personal Consumption Expenditures Price Index (PCE), the main index to measure the inflation level of the economy, is at 2.00% in the month of September 8. We expect the PCE index to reach 2.15% in the next six months and 2.30% in the next two to three years. Interest rates are commonly used by the Federal Reserve to diminish inflation and to keep it at its goal of 2.00%. prediction. For the industry as a whole, this will have one of the greatest effects. The Communication Services industry is very capital intensive due to the immense amount of infrastructure needed to provide service across the United States along with funding for the acquisitions of spectrum license. Knowing that rates will continue to rise during the short-term and long-term horizon, we adjusted T-Mobile s property and equipment, spectrum license, and long-term debt accordingly. T-Mobile will continue to invest in its property and equipment and spectrum license in order to provide a 5G network, but their long-term debt as a percentage of the two will most certainly decrease. They may look into other areas of financing whether it be equity issuances, short-term credit facilities that provide lower interest rates, or using their cash on hand. Most of the growth in property and equipment, spectrum license and long-term debt will occur in 2018 and 2019 but after the network has been optimized for 5G capabilities, higher interest rates will cause the company to reduce long-term debt. T- Mobile will then focus on reaching new, smaller customer geographies that require little infrastructure and then continue to pay down debt. Population Growth Another very important economic statistic critical to the Communication Services industry is the rate at which the United States population is growing. As can be seen in the graph below, population growth has reached its second lowest annual rate of 0.712% in Sources: Bureau of Labor Statistics 9, Federal Reserve Bank of St. Louis 10 Based on our inflation estimates, we believe that there will be a December rate hike along with several more in 2019 to drive down the 2.15% PCE index Source: Federal Reserve Bank of St. Louis In addition, fertility rates, currently at , are nearing all-time lows that haven t been seen since the 1970s s. This gives us confidence to expect a 0.700% population growth rate for 2018 and a longterm prediction of 0.680%. With little growth in 2

4 population, the other area to look at is penetration of phones amongst the population. In 2018, it s estimated that 82.1% or 267 million Americans will own a mobile phone 13. The United States population is approximately 325 million, 47.7 million of those people are under 12 years of age 14. It is unlikely that those under 12 years old will grow in phone penetration which leaves only 10.3 million Americans as possible customers. This information is one of the major reasons that we believe revenues will increase at a decreasing rate. Despite churn rate remaining relatively low, it will continually be harder to gain customers. As T-Mobile strengthens its subscriber growth, the competition among firms increases because all companies are fighting for the same customers. While T-Mobile s Un-Carrier initiative has been very successful in benefitting the customer more than other companies, the growth that T-Mobile has seen in the past will eventually come to an end. This may cause T-Mobile to further their efforts in customer service, but more importantly, they may increase cost of equipment sales to maintain their aggressive pricing. As a result, it is unlikely that we will continue to see their industry leading growth in the long-term and for that reason, we project the continuing growth rate for total revenue to be 3.59%. Consumer Confidence Consumer confidence measures the optimism of consumers towards the health of the U.S. economy and their expectations on employment, business performance, and income. In the month of October, the index rose to 137.9, its highest level since September of Source: The Conference Board 16 We believe that the Consumer Confidence Index can reach 139 by the end of 2018 because of the unemployment rate falling to its lowest level in decades, large corporate profits, and benefits from the tax cuts for consumers and corporations. In the longterm, because of our lower forecast for real GDP growth and rising unemployment levels, we believe it will fall down to 125. In the short-term, we see the high consumer index providing upward pressure on T-Mobile s revenues despite the relative inelasticity of Communication Services companies. If consumers are more willing to spend their disposable income, they will likely upgrade their phones or indulge in higher priced plans and options. However, we do not believe that this upward pressure on revenues is enough to outweigh the negative effects from slow population growth, decreasing real GDP and rising unemployment rates in the future. In the long-term, as consumer confidence decreases, the upward pressure on revenues will also diminish. Industry Analysis Industry Overview The Communication Services industry offers their customers phone service plans, mobile devices, and accessories. The revenue stream of a company who operates in this industry originates from the pricing of their wireless service programs and equipment they offer for purchase. Wireless service revenues include both prepaid and postpaid phone plans, wholesale customers and other connected device services. The second source comes from equipment revenues. These revenues include the purchase of mobile devices, tablets and other accessories that complement the firm s communication network 17. The Communication Services industry is currently in a mature life cycle stage. In the past few years this industry has experienced a lot of growth, the industry revenue is expected to hit $306.7 billion in Competition The Communication Services industry is a highly competitive industry consisting of a few key players. Based on total subscribers and shown in the chart at the top of the next page, Verizon is the largest with 35.1% of the market followed by AT&T at 33.8%, T- Mobile at 17.4%, Sprint at 12.4% and U.S Cellular with 1.2% of the market. 3

5 has been able to achieve strong revenue for only holding 17.4% of total market subscribers. Source: Statista 19 Using the most recent information, return on equity in 2017 for Sprint was 32.1%, T-Mobile was 22.2%, U.S Cellular 10.9%, Verizon 79.3% and AT&T 21.7% 20. When comparing firms, Verizon clearly did very well having the highest ROE followed by Sprint, T-Mobile and AT&T who performed around the industry average. Verizon was able to generate significant net income compared to their total stockholder equity. Furthermore, with almost complete saturation of the wireless customer base, retaining current customers is vital for success in the industry. A company s postpaid churn rate measures the retention rate of the company s postpaid subscribers: Sprint is 1.74%, Verizon s is 1.01%, T-Mobile s is 1.18%, AT&T is 1.08% and U.S Cellular is 1.21% 20. Sprint saw the most loss of customers followed by U.S Cellular, while the other firms performed around the industry average. Verizon performed the best by having the lowest churn rate. Being able to retain subscribers helps sustain revenues while net subscriber additions will grow those revenues each quarter. Sprint added 868,000 in 2017 while U.S Cellular added 1,024,000, Verizon added 2,041,000, T-Mobile 5,680,000, followed by AT&T with the most added at 12,0553, This translates to shifts in market share based on net subscribers. When operating in the Communication Services industry it is important to be able to offer significant returns while offering competitive pricing and differing plan options. The chart below shows recorded revenue for fiscal year AT&T led the industry at $160 billion followed by Verizon and then T-Mobile at $40 billion. AT&T and Verizon significantly outperformed their peers due to their market size. They combine to have 68.9% of the total subscribers in the market, this allows them to achieve these industry leading revenues. T-Mobile Source: Statista 21 Recent Development and Industry Trends Technology Improvements The largest trend in the Communication Services industry is the race to develop the 5G Network. A 5G network holds different possibilities in terms of future technology and revenue growth as well as new business development for telecommunication firms. This network will greatly increase the speed at which information and data can travel between devices. The network has two potential ways of being transmitted. One way is to be transmitted with small wave lengths like 28 GHz through the use of small cell sites. Small cell sites are portable base stations that have the ability to be placed in cities and dense landscapes 22. Small cell cites allow for higher frequency wavelengths to be boosted in order to build a complex communication network to support 5G data transmissions. This is the platform that Verizon plans on using with its significant holding of 28 GHz spectrum licenses 18. An alternative is using 600 MHz wave lengths to build a wireless network capable of supporting 5G connection, this is T-Mobiles plan. T- Mobile has acquired 42% of 600 MHZ spectrum licenses 18. The development of the 5G network is instrumental in remaining competitive in the near future and the long term. With competition for customers becoming more and more intense, staying ahead of the development of the 5G network will be dire. The development of the 5G network will provide the base to increase the capacity along networks which will enable them to support the Internet of Things (IoT) 23. IoT is the technological advancement of connecting hardware and software through the internet, allowing for technological devices to 4

6 communicate with each other. The development of an infrastructure to support the 5G network is instrumental in the success of the IoT. Pricing Competition With competition for customers being extremely fierce, companies have been trending towards offering competitive phone plans by bringing back unlimited data plans to attract customers from other companies. Unlimited talk, text and data allow companies to increase pricing pressure on each other in hopes of gaining customers. The four nationwide providers have challenged each other with a variety of plans including: Sprint s Unlimited Freedom Plan (unlimited voice, text and data options), AT&T s Unlimited Plan (Offering unlimited data plans), and Verizon s Unlimited Data Plan, and T-Mobile s ONE Plan (unlimited voice, text and data) 23. In an attempt to gain customers, one additional pricing trend is companies will compensate potential customers for the costs associated with switching wireless carriers. The fight over gaining customers in postpaid and prepaid services is responsible for the competitive pricing trends and changing service plans help to increase that pricing pressure. Porters 5 Forces Threats of New Entrants: Low Threat of new entrants is extremely low due to the many barriers of entry into the Communication Service industry. For any new firm it would take a large amount of capital to not only build a network but to also purchase the necessary spectrum licenses to support mobile telecommunication signals. In addition, certain mobile products are only offered through specific carriers making it difficult for a new firm to be marketable to a potential customer. Threats of Substitute: High With the largest firms in the continuingly trying to undercut each other s pricing, threats of substitutes are high. All firms offer extremely similar products, with some variation in reliability, as well as customer service.therefore, marketing campaigns targeting reliability as well as pricing options convey the competiveness in trying to obtain the already almost completely saturated customer base. Bargaining Power of Buyers: Moderate The reason buyers have moderate bargaining power is because of the similarities between the company s price offerings and option for service plans. This allows a customer to change to whichever company is offering the best product for the best price. The only reason bargaining power of buyers is not high is because some companies have customers sign two year contracts, which translates to customers being able to change providers at distinct times. T-Mobile is an anomaly where they do not require contracts on their service plans. Bargaining Power of Suppliers: High Compared to the bargaining power of buyers, the bargaining power of supplier is high. Mobile phones and accessories sold in T-Mobile stores are exclusively provided by outside suppliers. Suppliers consist of companies such as Apple, Samsung and Google. These firms are able to change the price of their phones due to the strong demand customers have for them. Since customer demand is so high, T- Mobile does not necessarily have an option to not supply those phones because they must remain competitive with the other firms who sell those phones and accessories. Competitive Rivalry among Firms: High The competiveness for gaining net subscribers between firms is high. Approximately 99.9% of the total market share consists of five companies. With limited number of firms and almost complete market saturation, competition is high. In addition, two of those companies (T-Mobile and Sprint) are attempting to merge, this would allow for the third and fourth largest firms to have the resources needed to compete against Verizon and AT&T in the development of the 5G network. All of these companies continually compete on price, cellular plan offerings and customer service. We believe this competiveness will increase because of the almost completely saturated market of phone users. For companies in this industry it has become extremely vital to not only retain customers but to find new ones who are unhappy with their current service. Increasing competition has been seen through T- Mobile releasing its unlimited data plan in August 2016, and the next day Sprint released a similar unlimited plan at a competitive price in the hopes of expanding its customer base 23. 5

7 Company Analysis Company Description T-Mobile is the third largest company in the Communication Services industry. It was founded in 1994 as Voice Stream Wireless PCS. It was acquired by Deutsche Telekom AG in 2001, where it was renamed to T-Mobile in In 2013, T-Mobile acquired MetroPCS Communications, which significantly grew their prepaid business segment. T- Mobile offers wireless services to its customers through postpaid, prepaid and whole sale markets 22. T-Mobile recently acquired Layer3 TV, this acquisition will allow them to provide on demand digital entertainment. T-Mobile is currently attempting to merge with Sprint, which would greatly increase T-Mobile s capital and network structure. Revenues T-Mobile revenues are structured into two main categories, service and equipment. Included in the service revenues are branded postpaid, branded prepaid, whole sale and roaming and other service revenues. From the chart below, total service revenues take up 75% ($23,803 million) of total revenues for the company. Total Equipment take up the remaining 25% ($8,062 million) of total revenues. This 25% includes equipment revenues and other equipment revenues 24. Equipment revenues are the actual sale of phones to customer s where the other equipment revenues consists of the equipment installment plan receivables T-Mobile receives from payment plans on mobile devices they sell 22. Equipment revenues bring in a loss of 417 million; this is a loss the company expects as it is a loss leader intended to subsidize the acquisition of customers. Marketing Strategy T-Mobile rebranded itself in 2013 by introducing its new strategy, of the Un-carrier strategy. This initiative is meant to portray T-Mobile as a new type of provider. The goal is to change the status quo and change the norms of customer service and customer satisfaction. The company believes that the longstanding tradition of its competitors rules and norms are unfair to the customer. This marketing strategy directly targets its competitors, Verizon, AT&T and Sprint 25. Specifically the goal is to gain subscribers and business through changing rigid annual phone plans, making data plans friendlier and tailoring phone plans towards benefiting the customer. The most recent change is attributed to the company adding more value to its service plans by creating a 24/7 customer service line, called the Team of Experts. This new addition to the company s customer service plan will allow customers to call them with any problem at any time of the day. The graph below shows the upward trend in subscriber growth that the Un-carrier market strategy had and continues to have on T-mobiles market share. The introduction of the Un-carrier strategy in 2013 caused a significant growth shift in the net subscriber base from the once almost stagnate net subscriber base as depicted in the chart below. Source: Statista 26 Source: SEC 24 Service Plan Options T-Mobiles branding itself as the Un-carrier, allowed for the implementation of new service plan which is its primary service plan for its customers. T-Mobile offers T-Mobile ONE, offering unlimited talk, text and 4G LTE data with all service fees and sales tax included in a single advertised price. Any eligible customers using less than 2GB of data on their line can receive up to a $10 line of credit on their next bill. The next tier of this plan is called T-Mobile One+, 6

8 offering unlimited high definition video, unlimited Gogo inflight internet on domestic flights, and up two times faster wireless speeds in up to 140 different countries when traveling. Through the implementation of these offerings, T-Mobile has managed to continue to hold a steady ARPU compared to other firms 22. The chart below shows that in Q3 of 2018 T-Mobiles ARPU is 46.17, compared to Verizon s at 46.17, Sprints at 43.55, U.S Cellular at and AT&T leading at They are just below the industry leader and performing above average in ARPU of the industry leading firms 27. Source: Statista 28 Earnings Report Analysis In quarter 3 T-Mobile gained 1,079,000 branded postpaid customers 29, which greatly exceeding expectations 646,000 subscriber 20. As postpaid subscribers become the next main customer focus of the industry, T-Mobile is positioned well to capture much of the growth in this area. Their competitive phone plans, growth in green field markets and continuing there low churn rates will help to boost growth. By targeting these greenfield markets along with developments in customer service and network quality and size, T-Mobile will continue to see record setting growth in the postpaid customer section. Quarter 3 branded postpaid churn rate was 1.02% which is an increase from their quarter 2 churn rate of 0.95% 29, which was the company s lowest churn rate ever. The continual low churn rate is a key statistic to show how T-Mobile not only attracts customers but continues to retain them at an extremely high rate which is vital in an industry that is continually fighting for each firms customers. Management is forecasting that T-Mobile, by the end of fiscal year 2018, will have customer additions of around 3.8 to 4.1 million. For the fourth quarter ended December 2018 EPS expectations are $0.98. Finally with the 5G network race management is estimating to have 5G in six U.S cities by the end of 2018, this cost takes up most of their estimate of CAPEX being 4.8 to 5.6 billion 29. Strengths T-Mobiles greatest strength is their differentiation in terms of flexible and transparent phone plans and their initiatives focused on improving customer service. Through this differentiation they have been able to sustain one of the lowest churn rates for postpaid subscribers in the market as well as increasing net subscriber growth. The Un-carrier marketing strategy has provided T-Mobile with a churn rate of 1.02%. In addition, quarter 3 of 2018 marks the 22 nd consecutive quarter that T-Mobile has added over a million net subscribers 30. They led the industry this past quarter in net subscriber additions of branded postpaid subscribers for the 19 th consecutive quarter 30. All of these strengths have continually increased T-Mobile s revenues. This has allowed them to grow as a company, whether it be through expansion of infrastructure, acquisition of spectrum licenses, or building out their Un-carrier branding strategy. Weakness T-Mobile has one large weakness, the company s average revenue per user has been decreasing for the past five years. In 2013 the company had an ARPU of $54.50, in quarter 3 of 2018 they reported an ARPU of $ This number is similar to some of T- Mobiles much larger competitors like Verizon and AT&T but those competitors have a much larger postpaid subscription base. The decreasing in ARPU has been attributed to decreasing margins because of their competitive pricing. These prices do attract customers which is their goal, but with almost entire market saturation and decreasing ARPU, T-Mobile will have decreasing margins which will negatively affect the company s earnings per share. Opportunities T-Mobile is developing new potential revenue opportunities by releasing a 5G network in 6 of the top 10 markets in the U.S, including New York and L.A 32. This will position them well for the release of the first every 5G capable phones that will be released in This opportunity builds into the potential revenue streams of the Internet of Things. By 2025 the IoT is expected to earn 3.9 to 11.1 trillion in revenue, this provides opportunity for the investment of capital into T-Mobiles 5G network to be extremely useful 33. 7

9 Threats The major threat to T-Mobile is their market size based on net subscribers. As 5G begins to replace 4G LTE as the new network of the country, T-Mobile might struggle to keep up with their larger competitors, like AT&T and Verizon. Given their larger market share, they may be better equipped to develop their infrastructure to support the 5G network. Additionally, AT&T and Verizon also offer in home services such as broadband internet which the ease of bundling services may be appealing to customers rather than getting multiple services from multiple providers. Investment Positives T-Mobile added 2.6 times net subscribers as their closest competitor, Verizon, last quarter 32 Q3 added a 1.02% churn rate which is a company record for their lowest churn rate ever in Q3 32 T-Mobile has the second largest number of prepaid phone subscribers in the industry 34 The Un-carrier marketing strategy has been extremely successful in gaining market share since its release in 2013 Investment Negatives Continually decreasing ARPU, which depending on growth of subscriptions, can have a negative outlook on earnings per share as well as decrease margins 31 In an industry dominated by capital structure, T- Mobiles size is of concern due to the increase of necessary purchasing of spectrum licenses, and equipment for 5G network development Merger and Acquisition The business consolidation between T-Mobile and Sprint will combine the third and fourth largest U.S wireless telecommunication companies as a measure of total subscribers. This merger is currently on a 180 day delay by the Federal Commission Council while they investigate whether or not the merger will benefit the public. This merger could provide T-Mobile with the ability to expand their network and provide them additional resources in their attempt to build their 5G network. We have decided not to include this acquisition in our model because of the uncertainty surrounding the merger. Valuation Analysis In order to determine the value of T-Mobile s share price, we utilized a multitude of different valuation techniques, consisting of: discounted cash flows, economic profit, relative valuation, and the discounted dividend method. The discounted dividend method was not effective in creating a reasonable value for T-Mobile s share price due to the fact that they do not issue dividends, nor do they intend to in the future. The discounted cash flow and economic profit methods proved to be the most helpful while the relative valuations provided some insight on T- Mobile. Below, we will discuss the key assumptions underlying our valuation along with the different valuation methods. Revenue Decomposition: Just as T-Mobile does in their annual reports, we broke down revenue according to the six distinguishable streams that represent total revenue. Overall, the two most important segments are postpaid and prepaid revenues. Historically, postpaid churn has been decreasing year over year due to T- Mobile s Un-carrier initiatives. We predict that postpaid phone revenues will steadily decline to a continuous 3.5% year over year growth despite their continued low churn rates and Un-carrier initiatives. Postpaid phone growth tends to increase as the economy strengthens and considering that we see gross domestic product growth slowing down to the 2.5% range, postpaid subscribers will diminish. Additionally, as the 5G network continues to develop, T-Mobile will likely find it more difficult to pull customers away from their current providers, being as that we see T-Mobile as slightly behind in 5G development. Average revenue per user (ARPU) is projected to decrease due to continued pressure on revenue from pricing initiatives. In regards to prepaid revenues, we believe that T-Mobile will hit a growth peak in 2019 and then steadily decline to 2% in Prepaid phone growth has been strong in the past and we believe it to outperform the industry due to 5G being available by 2019 and T-Mobile s aggressive unlimited plans. Despite this, T-Mobiles market share of approximately 28% places it just behind the market leader, Tracfone which leaves little room to grow as strongly as before (19). Also, T-Mobile s rebranding of MetroPCS along with the trend towards postpaid phone subscriber growth further pushes us to believe 8

10 that the postpaid segment will be the focus of the industry. Average revenue per user (ARPU) will rise due to continued price increases and low churn rates for the segment. Operating Expenses The three main expense for operations are cost of services, cost of equipment, and selling, general, and administrative costs. These three costs were projected based on their percentage of revenues. In the past, they remained fairly constant and we believe that it is best to continue with these percentages to accurately reflect costs in the future. Most notably, we estimate that selling, general and administrative costs to remain high and grow fastest from 2018 to This is due to our belief that T-Mobile s branding as being the Un-carrier requires it to provide great customer service plans and initiatives, an area where many Communication Services companies struggle. Due to ideas like Team of Experts, costs will rise as they continue to keep churn rates at industry lows and steal market share away from competitors. Spectrum Licenses / Property & Equipment As previously stated in this report, the most important trend in the industry is undoubtably the progression to the 5G network. In order to compete with the other players in the industry, each company must acquire the frequency licenses that work best with 5G and upgrade their infrastructure so that it is capable of providing 5G to its customers. T-Mobile just added an immense amount of spectrum last year but it is unlikely that there is much spectrum left to acquire. Lower frequencies such as 700Mhz and 600Mhz work best but have largely been bought by companies already(source of some kind)(another source to use if I mention the most recent auctions to come With this in mind, we increased spectrum at a moderate percentage, with most of the growth happening until We believe 2018 to 2020 represented to most important time to acquire 5G spectrum being as that it will be the build out phase of the network nationwide. In terms of property and equipment, the same line of thinking for growth carried over. Upgrading their infrastructure will be most important from now till 2020 so their highest growth will occur then. Cost of Equity Our cost of equity was calculated using the capital asset pricing model. The inputs for each variable are as follows: Risk Free Rate: 3.19% 34 Market Risk Premium: 5.32% 35 Raw Beta: 0.83 The risk free rate was sourced from the Federal Reserve s 10 year treasury yield. Our market risk premium is derived from a professor at New York University named Aswath Damodaran. His calculations and valuations are respected across the financial industry and are considered to be an accurate representation of the spread between the return of the market and the risk free rate. Lastly, the raw beta comes from Bloomberg s calculation of T- Mobile s beta. When all of these assumptions are used in the capital asset management method, we calculated the cost of equity to be 7.32%. Cost of Debt The pre-tax cost of debt was calculated using the yield on the most recent public bond issued by T- Mobile. Their ten year bond, rated by Moody s as Ba2, has a yield of 6.56%. We calculated our marginal tax rate to be 24.3%, a sharp drop from historical rates due to the recent tax cuts. Our aftertax cost of debt came out to be 4.97%. Discounted Cash Flows (DCF) / Economic Profit (EP) The DCF model was constructed by subtracting out capital expenditures from our NOPLAT over a 6 year period, due to the belief that 2023 represents a steady state of growth for T-Mobile. A continuing value formula was used to value the 2023 free cash flows for the indefinite future of the company. After this, we used our WACC to discount all cash flows and accounted for all non-operating variables to arrive at our price. The EP model was calculated by finding the difference between ROIC and WACC and then multiplying this by beginning invested capital. We then used a continuing value for the same reason as in the DCF model and discounted with WACC. After accounting for all non-operational we calculated a share price of $72.89 for both models. When adjusted to the 9 th of November to account for the partial year, the price was $ We believe that the discounted cash flow and economic profit models gives us the most accurate valuation of T-Mobile s share price 9

11 because unlike the discounted dividend model and the relative valuations, all important assumptions made in the model make up the projected share price. WACC, revenues, expenses, and balance sheet accounts all contribute to the calculation and we believe that this encompassing formula gives us a dependable price. Dividend Discount Model The dividend discount model was calculated by discounting all of the dividends by the cost of equity and using a continuing value of the last dividend to compute a projected share price. We do not believe that this model is accurate because T-Mobile does not, nor will not, issue a dividend for its shares. Since the model is predicated on an assumption that does not exist, we have no reason to believe that it is accurate in predicting a valuation. Relative Valuation Our relative valuation metrics were based on data from AT&T, Verizon, Sprint, and Comcast. We believe that these companies comprise the closest competitors to T-Mobile in the Communication Services industry. The two metrics that we decided to use are the price-to-earnings (P/E) ratio and the enterprise value over earnings before interest, taxes, depreciation and amortization (EBITDA). When we applied the industry average P/E ratio to calculate T- Mobiles price, we found it to be for 2018 and for After analyzing this result, there are multiple ways one can think about it. First, we thought that T-Mobile s industry exceeding P/E ratio shows it as being overvalued, and that its stock should trade for less. In contrast, a high P/E can also mean that investors are expecting earnings to grow in the near future. We believe that since T-Mobile is a growth company and has been performing at the top of the industry for countless earnings quarters, it is very reasonable to obtain a low stock price when using industry averages. We removed Sprint and Comcast because their ratios would skew the data. The EV/EBITDA metric produced largely the same results with a stock price of $47.69 for 2018 and $44.80 for We used this metric because we wanted to evaluate the earnings of each company regardless of depreciation because of the large amount of property, plant and equipment in the industry. We believe that projected stock prices were low because of the enterprise value. Due to the fact that enterprise values take into account the value of the company in the future, much like our DCF model, we believe that it is reasonable to believe that T- Mobile s high growth gives it an inflated enterprise value. This, in turn, gives T-Mobile a higher EV/EBITDA multiple than the industry average. Sensitivity Analysis Beta VS Equity Risk Premium In order to investigate our cost of equity more closely, we analyzed the stock price by changing the beta and equity risk premium. Beta is one of the most debated assumptions put into the capital asset pricing model due to the various ways that you can calculate it so we thought it would be useful to get a range of different values. We started with our Bloomberg estimate of and saw that by changing it in increments of 0.03, there was a large change in stock price. Mathematically, as beta approaches one, it has less of an effect on stock price. For our equity risk premium, we changed Aswath Damodaran s estimate by increments of 0.2%. From this, we can see that the average performance of the market has a large impact on the price of T-Mobile s. Depending on which index you use as the market return, the price will increase for smaller average market returns and decrease for larger average market returns. Considering market risk premium is another highly argued concept, we thought it was best to test it across a range of values. CV Growth Rate VS Pre-Tax Cost of Debt The continuing value growth rate is one of the most important assumptions in our model being as that much of the value in our DCF and EP models originates from the formula used in the continuing value year. By changing our original estimate of 2.5% by 0.2%, we can see that even a small change has large impacts on our intrinsic value. Our pre-tax cost of debt has a much smaller impact on our price as we changed it by 0.2% in either direction. As interest rates rise due to the Federal Reserve, we can expect the pre-tax cost of debt to increase throughout the years. Also, as T-Mobile continues to leverage its balance sheet, its publicly traded bonds could drop in rating, thus increasing the cost of debt. Marginal Tax Rate VS Risk Free Rate The marginal tax rate and the risk free rate were two more areas of interest in terms of our WACC calculation. We wanted to see which variable had a 10

12 greater effect on our intrinsic value and which most likely impacted our company wide cost of capital the greatest amount. After changing the marginal tax rate by 1.5% from our original estimate of 24.3%, we saw that there was a small effect on the stock price as opposed to our risk free rate. Due to the mathematical calculation of WACC, it is most likely that risk free rate has the larger impact being as that it is added directly into the capital asset pricing model. We increased and decreased our estimate of 3.19% by 0.3% and saw a great change in our intrinsic value. In the future, a higher risk free rate is possible but is unlikely to change much due to the financial security of the U.S. The marginal tax rate has the potential to change depending on the political climate of the country, most likely resulting in an increase in taxes if a change is made. Branded Postpaid Revenue Growth 2023E VS Cost of Services Growth 2023E Two of the most impactful operating components of our model are the growth rates of our postpaid revenues and cost of services. Our postpaid revenue growth rate of 3.5% is changed by 0.5% with little effect on the share price of the company. In contrast, as we changed the growth rate for cost of services by 0.5%, we saw a much more drastic effect on share price. Since cost of services is calculated as a percentage of service revenues, the change in margins has more impact than simply changing the amount of revenue for one segment. T-Mobile has historically become more efficient with its operating costs but we believe there is still room for improvement. Branded Prepaid Revenue Growth 2023E VS Cost of Equipment Sales Growth 2023E Another area of interest for our operations is the prepaid revenue growth compared to the cost of equipment sales growth. We started with an estimate of 2.0% for prepaid revenue growth and altered it by 0.5%. Much like postpaid revenue, our stock price did not vary by much. When we changed our cost of equipment estimate of 27.3% by 0.5%, it had a similar degree of impact to cost of services. This just reinforces the idea that margins play a big role in calculating the intrinsic value of the company. Cost of equipment sales have been very high for T-Mobile in the past and we expect them to increase slightly over the forecast period due to the aggressive pricing plans. 11

13 References 1. Mutikani, L. (2018, August 29). U.S. second-quarter GDP growth raised to 4.2 percent. Retrieved October 29, 2018, from 2. Gross Domestic Product, 3rd quarter 2018 (advance estimate). (n.d.). Retrieved from domestic-product-3rd-quarter advance-estimate 3. Quarterly Growth of the real GDP in the United States from 2011 to (2018). Retrieved October 27, 2018, from percent-chance-from-preceding-period-inreal-gdp-in-the-us/ 4. Morath, E., & Torry, H. (2018, October 05). U.S. Unemployment Rate Falls to Lowest Level Since Retrieved October 26, 2018, from 5. DePillis, L. (2018, October 16). US wages see third quarter increase. Retrieved October 16, 2018, from /q3-weekly-earnings/index.html 6. Wage Growth Tracker. (2018, November 8). Retrieved October 10, 2018, from 7. Bureau of Labor Statistics Data. (2018, November 12). Retrieved October 15, 2018, from Personal Consumption Expenditures Price Index. (n.d.). Retrieved October 19, 2018, from 9. Bureau of Labor Statistics Data. (2018, November 12). Retrieved October 19, 2018, from SA0L1E?output_view=pct_12mths 10. Effective Federal Funds Rate. (2018, November 01). Retrieved October 22, 2018, from DS 11. Population Growth for the United States. (2018, July 20). Retrieved October 30, 2018, from OWUSA 12. Fertility Rate, Total for the United States. (2018, May 16). Retrieved November 7, 2018, from RTINUSA 13. United States mobile phone penetration Statistic. (n.d.). Retrieved November 2, 2018, from forecast-of-mobile-phone-penetration-inthe-us/ 14. Pop1: Child Population. (n.d.). Retrieved November 8, 2018, from n/tables/pop1.asp 15. CNBC. (2018, October 30). Consumer confidence rises to an 18-year high in October. Retrieved November 11, 2018, from er-confidence-rises-to-an-18-year-high-inoctober.html 16. Bartash, J. (2018, September 25). Consumer confidence surges in September to 18-year high, near all-time peak. Retrieved October 11, 2018, from mer-confidence-surges-in-september-to-18- year-high-near-all-time-peak SEC Website. (2018). T-Mobile Q2 Report. Retrieved September 12, 2018, from / /tmus form10-q.html 18. Editor's Corner-Why the 28 GHz spectrum auction only covers 23.7% of the U.S. 12

14 population. (2018, April 20). Retrieved from FierceWireless. (n.d.). Wireless subscriptions market share by carrier in the U.S. from 1st quarter 2011 to 2nd quarter In Statista - The Statistics Portal. Retrieved September 12, 2018, from market-share-of-wireless-carriers-in-the-usby-subscriptions/. 20. Factset Research Systems. (n.d) Telecommunication Industry Key Metrics. Retrieved November 11, 2018 from Factset database. 21. Major US telecom providers revenue ranking 2017 Statistic. (n.d.). Retrieved from otal-operating-revenues-of-ustelecommunication-providers/ 22. The Importance (and Opportunities) of 5G Research. (n.d.). Retrieved September 9, 2018, from importance-5g-research/ 23. Implementation of Section 6002(b) of the Omnibus Budget Reconciliation Act of 1993, Annual Report and Analysis of Competitive Market Conditions with Respect to Mobile Wireless, Including Commercial Mobile Services. Retrieved September 11, 2018, from ily_business/2017/db0927/fcc a1.pdf 24. Document. (2018, November 10).SEC Emblem, Retrieved from 9/ /tmus for m10- k.htm#sa58366f90f4f5e97af5b12fc11 4AD Sherman, J. (2013, January 23). What is an 'Un-carrier'? We ask T-Mobile's Chief Marketing Officer, Mike Sievert. Retrieved September 17, 2018, from T-Mobile US customers/subscribers Statistic. (n.d.). Retrieved from otal-customers-of-t-mobile-usa-by-quarter/ 27. SEC Website. (2018). T-Mobile Q2 Report. Retrieved November 11, 2018, from / / index.html 28. ARPU wireless carrier United States Statistic. (n.d.). Retrieved from arpu-top-wireless-carriers-us/ 29. US Wireless Carrier Market Share Statista, -share-of-wireless-carriers-in-the-us-bysubscriptions/ 30. T-Mobile Website, T-Mobile s Third Quarter Earning Report. Retrieved from _financials/2018/q3/tmus-q Earnings-Release_FINAL.PDF 31. T-Mobile US ARPU (postpaid/prepaid) Statistic. (n.d.). Retrieved from -mobile-us-postpaid-prepaid-arpu/ 32. T-Mobile Quarter 3 Earnings Release. (2018, October 30). Retrieved November 11, 2018, from _financials/2018/q3/tmus-q Earnings-Release_final.PDF 33. Manyika, J., Chui, M., Bisson, P., Woetzel, J., Dodds, R., Bughin, J., & Aharon, D. (2015, June). The Internet Of Things: Mapping The Value Beyond The Hype. Retrieved September, 2018, from nsey/business Functions/McKinsey Digital/Our Insights/The Internet of Things The value of digitizing the physical world/unlocking_the_potential_of_the_int ernet_of_things_executive_summary.ashx 34. Bournique, D. (2018, February 20). Fourth Quarter, 2017 Prepaid Mobile Subscriber Numbers By Operator. Retrieved October 13