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T-Mobile US’s $26 billion plan to acquire rival Sprint shed light on a mature industry whose big domestic players must merge or transform themselves to give investors a reason to own them.
T-Mobile US and Sprint have agreed to merge in an all-stock transaction that values the combined company at $146 billion and Sprint at $59 billion. That second figure translates to a paltry 7% premium for Sprint, which was valued at $55.1 billion as of Friday’s stock market close. Sprint’s shares fell as much as 13% Monday after the announcement. T-Mobile was down as much as 6%, showing investors aren’t enthused about the merger agreement.
In a way, sales growth says it all: T-Mobile’s revenue is up 8% in the past year, while Sprint’s has flatlined.
It will be difficult for the deal to pass muster with regulators, who are concerned about reducing the number of major U.S. wireless telecom companies to three from four. Jacob Passy detailed consumers’ potential concerns with a tie-up between the companies when rumors were flying last year.
Meanwhile, the telecom players face the continuing problem of a maturing and competitive market for wireless services. This is why AT&T
and Verizon
have been working to diversify their cash-flow streams through acquisitions. AT&T purchased DirecTV in 2015 and is hoping regulators approve its deal to acquire Time Warner, which was announced in October 2016.
Verizon acquired AOL in 2015 and Yahoo’s internet business in June.
Ranking U.S. telecoms
Here’s how the four major U.S. wireless providers stack up in various categories. The companies are listed in order by market capitalization.
Stock performance
Here are returns for the four stocks, with dividends reinvested, through April 27:
| Company | Ticker | Market cap ($ billions) | Total return - 2018 | Total return - 3 years | Total return - 5 years | Total return - 10 years |
| Verizon | $213 | 0% | 19% | 21% | 147% | |
| AT&T | $203 | -13% | 13% | 16% | 48% | |
| T-Mobile US | $55 | 2% | 89% | 304% | 141% | |
| Sprint | $26 | 10% | 24% | N/A | N/A | |
| Source: FactSet | ||||||
For the three- and five-year periods, T-Mobilie has been the obvious winner. The following helps explain why.
Sales growth
Here’s a comparison of sales growth over the past 12 months for the group, based on the most recently available reported data through April 27:
| Company | Ticker | Sales - past 12 months ($ millions) | Sales - year-earlier 12-month period ($ millions) | Change in sales |
| Verizon | $127,992 | $123,623 | 4% | |
| AT&T | $159,219 | $162,616 | -2% | |
| T-Mobile US | $40,604 | $37,490 | 8% | |
| Sprint | $32,862 | $32,879 | 0% | |
| Source: FactSet | ||||
Once again, T-Mobile is the leader. Then again, Verizon’s 4% sales growth over the past 12 months is nothing to sneeze at for such a mature company.
Profit margins
A company’s gross margin is sales, less the cost of goods sold, divided by sales. If sales are increasing but the gross margin is declining, it could mean the company is facing pricing pressure or that it is offering unusually high discounts to juice sales. Here are the comparisons of the four companies’ gross margins and net income margins (net income divided by sales) for the past 12 months from a year earlier:
| Company | Ticker | Gross margin - past 12 months | Gross margin - year-earlier 12-month period |
| Verizon | 45.02% | 46.25% | |
| AT&T | 36.12% | 37.41% | |
| T-Mobile US | 42.02% | 39.20% | |
| Sprint | 33.33% | 30.20% | |
| Source: FactSet | |||
Verizon has had the best gross margins, but T-Mobile ranks a close second and its margin has improved.
Return on invested capital
A company’s return on invested capital (ROIC) is earnings divided by total equity and long-term debt. It measures how effective a company’s management is at deploying capital, and comparisons are most meaningful within industries. Here’s how the big four U.S. wireless providers stack up:
| Company | Ticker | Average return on invested capital - five years |
| Verizon | 11.5% | |
| AT&T | 6.8% | |
| T-Mobile US | 2.2% | |
| Sprint | -2.3% | |
| Source: FactSet | ||
The above is a comparison of annualized ROIC for the past 20 quarters. Verizon is the clear leader.
Dividends and free cash flow
Verizon and AT&T are well-known to be generous dividend payers. This year’s decline in AT&T’s share price has helped push its yield above 6%. T-Mobile and Sprint don’t pay dividends on common shares. Here’s a comparison of dividend coverage for the two U.S. telecom giants:
| Company | Ticker | Dividend yield | Free cash flow yield - past 12 months | ‘Headroom’ |
| Verizon | 4.58% | 5.45% | 0.87% | |
| AT&T | 6.05% | 8.44% | 2.38% | |
| Source: FactSet | ||||
A company’s free cash flow is its remaining cash flow after planned capital expenditures. It is money that can be used to increase dividend payouts, buy back shares, make acquisitions, fund other growth initiatives or for other corporate purposes. If we divided the past 12 months’ free cash flow by the current share price, we get the free cash flow yield, which can be compared to the current dividend yield to see if there is “headroom” to pay higher dividends.
Income or growth?
Fierce pricing competition and a mature market for wireless services make for tough times for the domestic wireless telecommunications business as a whole.
For yield-hungry investors who don’t already hold a lot of AT&T shares (in relation to the size of their investment portfolios), the stock looks attractive. The company appears to have plenty of cash flow to support significantly higher dividend payouts. Verizon is also covering its dividend comfortably, but the yield isn’t as attractive and its free cash flow yield has been considerably lower than AT&T’s.
For growth investors, T-Mobile has been the clear winner for recent sales increases and stock performance.