T-Mobile US: Ready To Lead The 5G Revolution

Originally posted in August 2018

What is 5G?

5G wireless networks use wide spectrum bands, dynamic computing, smart signaling and other advanced wireless technologies to produce a more efficient, more powerful telecommunications network. The performance metrics of these next generation network are truly stunning. Compared to 4G LTE, the time it takes for a wireless signal to be sent and returned to the mobile user will be reduced 50 to 100 times. 5G will have a latency period of only one millisecond. 5G also has much greater network capacity than 4G. Thanks to super wide spectrum bands, advanced beam forming and smart signaling technologies, and Massive MIMO antennae, 5G networks will be able to handle 1000X more data traffic than 4G LTE. This means an urban 5G network can easily support 1 million connected devices per square kilometer. All of this comes with mobile data speeds up to two orders of magnitude faster than current 4G LTE. Today’s 4G LTE services have average data speeds around 30Mbps. 5G networks will boast an initial 33X improvement in data speeds; the first 5G network deployments will deliver speeds of 1Gbps (or 1,000Mbps) to the mobile device.

5G is becoming known as the 4th Industrial Revolution or “Industry 4.0” in China. The value creation brought about by this new generation of communications technology will transform the world economy. Advanced capabilities of the 5G network will transform and revolutionize industries as the internet forever changed the world of business. 5G’s game breaking improvements in the crucial performance measures of latency, capacity, and speed will allow a future filled with smart sensors, connected devices, and smart infrastructure. A nationwide 5G network can eventually become the backbone of an autonomous driving network. Entrepreneurs, businesses, and consumers will discover creative new applications for this vast communication power. Network splicing and dynamic computing technology will allow the network to efficiently serve the specific needs of each user across a single powerful network. The 5G future offers so much more than glorified WiFi and rapid HD video downloads; 5G networks will support mobile augmented reality, smart cities, connected highways, smart farms, and so many more critical services. The wireless service provider that can best meet the 5G demands of the U.S.'s economy will find plenty of opportunities to create and capture value.

Spectrum Rights

In the world of 4G LTE, spectrum licenses were extremely important, but the move to 5G takes the criticality of spectrum rights to a whole new level. T-Mobile is in a great position with its spectrum holdings. Because of T-Mobile’s network efficiency and relatively lower number of customers, TMUS has not faced in its 4G LTE network the same overcrowding issues that have plagued Verizon and AT&T. T-Mobile has been able to provide better 4G LTE connectivity and mobile speeds than its competitors. When it comes to 5G, VZ and AT&T do not have any available low frequency spectrum to build a 5G network on. For this reason, they both are employing a network densification strategy, building high-powered, 5G-like, urban networks of fiber to "small cells" that employ mmWave wireless transmission. This will essentially provide city-wide Wifi service to their customers and help to solve their 4G LTE networks’ undercapacity issues, but in the mean time T-Mobile will be using its treasure trove of high range low and mid band spectrum to build a true nationwide 5G wireless network at relatively low cost.

Spectrum is currently the most valuable asset in the wireless industry; when T-Mobile and Sprint merge, they will have more spectrum rights than AT&T and Verizon combined. Not only will New T-Mobile have a huge lead in terms of overall spectrum, but they control some of the most valuable spectrum licenses. For instance, New T-Mobile will have a massive spectrum holding in the 600MHz and 700MHz bands. These frequencies are perfect for building a nationwide broadband network because they can propagate 40 miles or more and will also penetrate through walls. AT&T and VZ on the other hand have spent the last few years amassing wide bands of extremely high frequency, 24 GHz and higher, so called millimeter wave spectrum. These high frequency licenses are becoming plentiful as the FCC allocates more spectrum for consumer wireless use, but limited signal propagation at these short wavelengths creates problems. The maximum transmission distance for these high frequency microwaves is one kilometer and the waves cannot travel through walls but instead must be “bounced” to the target using complex beamforming algorithms. As a result of mmWave's limiting properties, AT&T and VZ need to spend about $250,000 per node to build a small cell “5G” tower every 1,000 square yards. Using this math, a nationwide 5G network built on mmWave would require an infeasible 6 million transmission nodes at a total estimated cost of $1.2 trillion.

After the merger with Sprint, New T-Mobile will have by far the broadest and deepest set of spectrum rights in the industry. Through heavy participation in past FCC spectrum auctions and opportunistic acquisition of other wireless companies like MetroPCS and now Sprint, T-Mobile has amassed an unmatched spectrum portfolio. New T-Mobile will have an average 319 MHz of spectrum in the top 50 markets. By comparison, AT&T will hold 177MHz and Verizon will hold 114MHz in the top 50 U.S. markets. The relative strength of TMUS's spectrum position has allowed it to build a 4G LTE network that outperforms Verizon and AT&T in speed and reliability and matches their coverage range. New T-Mobile's long range, low-band spectrum assets will allow it to build a nationwide true 5G communications network for less than one tenth the cost of Verizon or AT&T.

John Legere & The Un-carrier

The telecom industry was essentially dominated by the near duopoly of Verizon and AT&T. These two companies successfully capitalized on existing wireless technology and their legacy telecommunications assets to capture nearly all profits in the wireless industry. Unfortunately for consumers, both these companies have been failing to meet user demands for faster, more reliable service at lower prices. T and VZ have consistently saddled their customers with unfair service and overage fees, and long-term service contracts, instead of focusing on delivering value to consumers and solving customer pain points. This is where renegade CEO, John Legere, and T-Mobile's Un-carrier strategy excel. In 2013, Un-carrier 1.0 launched “Simple Choice” to eliminate contracts, data limits, and overage fees. Since then, TMUS has introduced free unlimited data for music streaming, complimentary monthly data rollover, free unlimited international data (albeit at slow speeds), unlimited video streaming from top services, and free high-speed data in Mexico and Canada, among other initiatives. Since implementing the Un-carrier, T-Mobile has kept customers' prices the same but raised the service level 10X.

T-Mobile prides itself on its ability to provide a faster 4G LTE network and far better customer experience than its competitors. T-Mobile's high network capacity allows it to aggressively acquire new customers, with incremental subscribers contributing only marginally to the overall cost of service. T-Mobile's customer first orientation and Un-carrier initiatives have taken the company from 33.4 million total subscribers in the beginning of 2013 to 75.6 million total subscriber in Q2 2018. T-Mobile doubled its revenues between 2012 and 2017 while decreasing ARPU's. (ARPU, average revenue per user, is a traditional measure of value capture used in the wireless service industry.)

John Legere and T-Mobile’s management team have spent the last five years focusing on important aspects of the wireless business like customer service, spectrum rights, and network efficiency. On the other hand, AT&T has pursued media/entertainment control and distribution strategies by purchasing DIRECTV for $48.5B + $18.6 debt assumption and acquiring Time Warner for $85B, while Verizon has purchased faded internet giants Yahoo for $4.48B and AOL for $4.4B. These backward strategies have given Big Red and Big Blue plenty of distraction and a huge debt load to manage just as the pace of 5G innovations accelerates.

T-Mobile has made its own much smaller media/distribution acquisition. In January 2018, TMUS purchased Layer3 TV for $325 million in order to launch a T-Mobile IPTV service. The new subscription-based television service will target mobile as well as in home users, and users will only pay for the channels they want. This acquisition will help T-Mobile to eventually provide subscribers with a high value "a la carte" TV service with mobile and high-res in home capabilities.

T-Mobile’s Network

The rapid build-out and expansion of T-Mobile’s 4G LTE network reflects the great skill of the company’s technical team, led by CTO Neville Ray. Today T-Mobile’s network covers 323 million “POPs” with 4G LTE service and will cover 325 million people by the end of this year. The network team is aggressively rolling out low band spectrum. 700 MHz deployment is “virtually complete,” and deployment of newly acquired 600MHz band continues at a “furious pace.” As of August 1st, low band spectrum is deployed to 289 million POPs and 600MHz is live in 992 cities and towns in 33 states.

Coverage and speeds depend on geography and usage, but on average, T-Mobile’s 4G LTE network greatly outperforms Verizon and AT&T in both upload and download speeds. Because T-Mobile uses wide bands in the lower 1900 MHZ, 1700 MHz, 700 MHz, and 600 MHz frequency ranges and has fewer customers on their network, T-Mobile is able to provide much better coverage and connectivity than Big Blue or Big Red. T-Mobile owns enough of this high-quality low band spectrum per customer to provide unmatched network performance and speeds to mobile users. One underappreciated strength of T-Mobile network is the scale benefits of its existing capacity. T-Mobile has the ability to add millions of more customers to their network without meaningfully diminishing the experience of existing customers. Each one of these marginal customers will be extremely profitable as the network is already in place and has available capacity. Each customer TMUS adds from VZ or T will drive the company’s overall EBITDA margin higher and higher.

The next task for Neville Ray and his team is 5G deployment. The plan is to bring 5G to 30 cities by the end of 2018 starting with New York, LA, Dallas, and Las Vegas. The 5G network will utilize the 600MHz spectrum band that TMUS acquired at auction for $8 billion in 2017 and use both 4G and 5G bandwidth simultaneously for dual connectivity. The current 4G LTE network gear on T-Mobile’s 600MHz spectrum is compatible with 5G, requiring only a software update. Nationwide coverage will come in 2020 with New T-Mobile's 5G deployment on T-Mobile’s 600 MHz spectrum and on Sprint’s 2.5GHz spectrum. The integrated Sprint & T-Mobile 5G network (a.k.a. New T-Mobile’s 5G network) will include 85,000 macro cell sites, 50,000 small cell sites, and cost less than $40B.

Q2 2018 Performance

On August 1st, the company posted Q2 2018 results and held its earnings call livestream. In the quarter, T-Mobile captured roughly two thirds of the entire telecom industry’s postpaid phone service growth and grew at least twice as fast as Verizon, AT&T, Sprint, or Comcast in postpaid phone service, giving the company its 18th straight quarter of leading the industry in postpaid service revenues growth. 1.6 million total (post-paid and prepaid) net customer additions in the quarter extended TMUS’s streak of over 1 million net subscriber adds to 21 straight quarters.

T-Mobile’s rapid subscriber growth showed no signs of slowing down this quarter and results indicate a possible re-acceleration of growth. T-Mobile’s overall postpaid porting ratios (the proportion of customers switching from one carrier to another) for the quarter were 1.86, compared to 1.69 in Q1 and 1.38 in Q2 2017. This overall porting ratio includes porting ratios higher than 2:1 against both AT&T and Verizon. In addition to these fantastic porting ratios, T-Mobile surprised analysts by reporting the first ever quarter with branded postpaid phone churn below 1%.

Also in the quarter, independent measurement services Ookla and OpenSignal recognized T-Mobile as having the fastest download and upload speeds in the industry. TMUS’s 4G LTE network tested at an average download speed of 31.8Mbps, much faster than competitors.

T-Mobile Financials

For TMUS’s Q2 2018 financial results, Service Revenues set a new record, growing 7% YOY to $7.9 billion. Total Revenues were $10.57B. Net Income increased 35% YOY to $782 million. The quarter’s Adjusted EBITDA also set a new record, growing 7.3% YOY to $3.2 billion. Adjusted EBITDA margin came in at 41% thanks in part to the efficient (and rapid) roll out of 600MHz spectrum, lower S&GA, and stabilized ARPU just below $50/month. Free cash flow was up 61% YOY to $774mm despite 21% YOY increase in Capital Expenditures.

Since the telecom industry was recently dominated by a duopoly, operating margins are generally high. ARPU (average revenue per user) metrics were pressured during promotional pricing wars featuring Sprint and T-Mobile, but TMUS's ARPU has been mostly stable over the last year, dropping just 1.2% YOY and 0.3% sequentially to 46.52. In the industry as a whole, ARPU has actually risen a bit. This quarter the CPI for wireless phone service had its first gain since July 2016, rising 0.3% YOY in June. T-Mobile is playing a scale/market share game, consistently pricing below competitors while providing better service. TMUS is like the young Amazon of the telecom industry, except TMUS has EBITDA margins over 40% and expects 55-57% EBITDA margins by 2025.

A couple of notes on the outlook and recent boosts in guidance. The FY 2018 outlook for branded postpaid net customer adds was boosted from 2.6 - 3.3 million, and the company is now guiding for 3 million to 3.6 million in net postpaid adds. With the new revenue recognition standard, FY 2018 Adjusted EBITDA is now guided for between $11.7 billion and $12.4 billion. The free cash flow CAGR estimate over the next three years is 46% to 48%. FY 2018 CapEx is expected near $5.3 billion, including expenditures for 5G deployment and excluding capitalized interest.

The Merger & New T-Mobile

The Sprint T-Mobile merger is good for customers, good for jobs, and good for the nation. New T-Mobile, the name of the merged Sprint and T-Mobile company, will lead the U.S. 5G revolution and leapfrog China Mobile and Huawei as the global 5G leader. Competition will be enhanced as there will be three telecom providers competing to win the U.S. 5G market, and customer value will be enhanced across the board as AT&T and Verizon and cable/IP service providers like Comcast will be forced to increase their investments in order to keep pace with rapid 5G evolution. Without New T-Mobile, T and VZ will have little incentive to ever provide true 5G broadband service to its customers. On day one of the merger, more jobs will be created at both Sprint and AT&T. Minimal rationalizations at corporate will be far outweighed by store count increases and huge network investments. 5G will bring an estimated $500B boost to U.S. GDP and create 3 million jobs in the U.S. as the 5G economy is built upon the foundation laid by New T-Mobile. The benefits of this merger are overwhelming, and the DOJ will find it impossible to build a legitimate case to block the deal.

For investors, the synergies of this deal are mouth-watering. The deal offers a total of $43B in synergies. $26B of these synergies come from savings generated by operating one large network at capacity as opposed to two separate networks at 2/3 capacity. T-Mobile provided a shining example of how to complete a large scale network integration with their successful integration of the MetroPCS network in 2013, completing the integration under budget and ahead of schedule. The integration of the two networks will be accomplished by selecting the best 75,000 macro cell sites out of the total 110,000 currently in the two networks. Then 10,000 additional sites will be added on to optimize the network for a total of 85,000 macro cell sites. As part of the 5G network densification, 50,000 strategic small cell sites will complement the network and relieve capacity pressures in high data traffic areas.

After Year 1, Total Revenues of the combined company will be $75B with Services Revenues of $55-57B. Adjusted EBITDA will be $22-23B. And EBITDA margins will start at 40-42%. As stated before, the company expects EBITDA margins to grow to 55-57%. With the merger, T-Mobile’s Cash Flow will go from $1-2B this year to $10-11B in 2022 to $16-18B of annual FCF in 2025. At the time of the merger, the combined company’s Net Debt/EBITDA Leverage will be 2.9x, but increased free cash flow will allow debt leverage to be taken below 1x in only 3-4 years.

Closing

By Enterprise Value, Verizon and AT&T are by far the largest telecom providers in the world. Both have EV's (Net Debt plus Market Capitalization) well over $300B. T-Mobile, on the other hand has an Enterprise Value of only $85B, but seems to have the inside track on 5G evolution. After the merger with Sprint, New T-Mobile will be a roughly $135B EV company with at least twice as much spectrum as VZ or T. T-Mobile will also benefit from its brand-associated customer goodwill and a management team with an aptitude for capital allocation.

Based on its economic merits, the Sprint/T-Mobile merger will be approved. Once both companies’ spectrum holdings are combined, New T-Mobile will have assets in place to build the first and deepest nationwide 5G network. This network will far outperform AT&T and Verizon's 5G efforts in suburban and rural areas and should provide comparable service in urban areas. Competitors AT&T and Verizon do not have the low frequency spectrum to launch a nationwide 5G network in any economical way. Their fiber and mmWave urban network densification strategy will not scale beyond urban populations. As a result, New T-Mobile will have first mover advantage in deploying their broad and deep nationwide 5G network, and TMUS will take huge wireless market share from the incumbent VZ and T.

Beyond having the spectrum capacity and competitive opportunity to lead the 5G evolution, New T-Mobile will have the financial resources to build this network and the corporate team and culture to build it right. The new company will have a Net Debt/EBITDA of 2.9x, and high cash flows will bring Net Debt/EBITDA below 1x within 3 or 4 years. Operating and CapEx Synergies of this deal will begin to be realized immediately as $6 billion falls to the bottom line in each of the first five years of integration. The technology team, led by CTO Neville Ray, has an outstanding track record of network design, integration, and cost control. Management says nationwide 5G rollout by 2020, which given T-Mobile's track record suggests they will have nationwide 5G well before the end of 2019.

New T-Mobile is committed to “bringing broad and deep nationwide 5G to Americans as fast as possible." With T-Mobile’s management expertise, the power of the Uncarrier brand, and the support of America, T-Mobile is clearly the best bet to lead the 5G revolution.