Mid-winter greetings from tornado-ridden Lake Norman, NC, and snow-packed Fraser, CO, where we took in some excellent ski conditions following the Colorado Wireless Association Education Conference in Denver. It was terrific meeting and reacquainting with many of you. A PDF copy of the presentation will be available for download today here: CWA Presentation
We are going to continue our earnings discussion this week with a focus on T-Mobile and Verizon earnings announcements. Because of several requests to comment on the recent activities surrounding potential government investment in equipment providers, we’ll spend some time discussing the pros and cons of state sponsorship/ownership.
T-Mobile 4Q Earnings Announcement – Ready and Waiting
There are many things to say about T-Mobile’s earnings and the corresponding conference call (the last one with John Legere as CEO, and we presume one of the last ones for Braxton Carter as CFO). The bottom line, as we discussed with Sprint’s earnings in our earnings preview TSB (here) is free cash flow. Here’s that schedule for T-Mobile, including and excluding merger-specific costs, for the last three years (from their 10-K):
Cash from operations increased $2.9 billion over 2018. Even as subscribers grew, securitization proceeds fell by $1.5 billion and capital spending for the year, driven by 600 MHz expansion and 5G enablement, grew by $850 million. Overall, T-Mobile generated $4.3 billion in free cash flow and, for the first time since their securitization efforts started, generated enough net cash to render maximum leverage in any securitization discussions (the result being that T-Mobile will only take the ones that make the most business sense, and manage the higher risk/ discounted securitizations in-house). This point should not be lost, especially as Mr. Carter noted that 2020 Free Cash Flow guidance does not include any forecasted proceeds from securitizations.
This increase in profitability has helped T-Mobile’s interest leverage ratios. At right is the latest trend from T-Mobile’s Investor Factbook. The most remarkable thing about the lowering of the black line (Net Debt to Last Twelve Months or LTM Adjusted EBITDA) is that it has not followed the repayment of debt principal (total debt excluding tower obligations has remained flat over the past five years) but solely from the increase in profitability. While a sub 2.0x ratio is derived primarily in preparation for the Sprint merger (Gross T-Mobile combined debt will be in the upper $69-71 billion range), it’s a notable achievement.
Separately, it’s also worthwhile noting that T-Mobile does not have retirement obligations (OPEB) that Verizon and AT&T currently carry ($18 billion for Verizon and $19 billion for AT&T as of end the of 2019). To have healthy cash flow with < 2.0 debt to EBITDA ratio, relatively small deferred tax liabilities ($5 billion vs. $35 billion for Verizon and $60 billion for AT&T) and no OPEB commitments leaves T-Mobile with more balance sheet flexibility than their two larger competitors.
So why the tepid 4% 2020 standalone EBITDA growth guidance (it seems like every analyst on the call asked this question in a different manner)? After discussing the EBITDA headwind created by changes to the revenue recognition accounting standard, Mr. Carter explained:
“We are continuing a very aggressive rollout. It’s amazing what happened during 2019, what Neville and the team accomplished on the 600 MHz rollout in 5G. We have very large aspirations for this during the year, which does drive more OpEx into the question. You’ve got to build it before they come.”
As background, here’s the cleared vs. market-ready 600 MHz schedule as reported by T-Mobile:
T-Mobile has increased their 600 MHz POP coverage by ~90 million from 2Q to 4Q (cleared and reported), and still has a 27 million POP gap which will come online in the first half of 2020. On top of the 27 million gap (275 cleared less 248 reported), they have an additional 45 million POP deployment left to complete in order to cover the entire country with 600 MHz.
Here’s what’s likely happening:
- T-Mobile is seeing better than expected response to their 600 MHz marketing efforts. This is driving increased backhaul (op ex) and operations costs (phone costs, commissions, service). Because most customers need to buy or upgrade their device to get the 600 MHz radio (LTE Band 71), this places some pressure on equipment subsidies (which are $0-25 profit at best, and a $200-250 per device subsidy at worst).
- More demand is driving capacity augments faster than expected, and the incremental costs to grow in less densely populated areas (and with 600 MHz spectrum) tends to be weighted towards backhaul as opposed to capital (fewer site augments, more bandwidth per site).
- Territory is being expanded, but likely with a new “first year penetration” figure that builds on the lessons learned from the previous 600 MHz implementations. This is requiring more capacity deployments at the tower as well as higher capacity backhaul. This might be the source of Mr. Carter’s “You’ve got to build it before they come” comment.
While T-Mobile has done their fair share of long-term fiber deployments, our guess is that as they get further from the metro area, the likelihood that they will find leased fiber at attractive rates diminishes. This leads to less backhaul capitalization and more period expense. Economics are challenged, but churn is likely much better leading to equal or better Total Customer Value (TCV).
These assumptions, plus some uptake from new device equipment financings, leads us to believe that T-Mobile will see excellent take rates and higher launch productivity (ultimately leading to much faster EBITDA generation). And the benefits accrue whether New T-Mobile occurs or not.
Speaking of which, Craig Moffett asked the question many of us have been wondering for some time: Why not just lease Sprint’s Band 41 spectrum for a long time as a merger backup plan? After assuring Craig that the merger would be approved, John Legere responded “there are certainly a myriad of things that Sprint and we could consider doing to harbor some of what would’ve taken place.” If T-Mobile has already readied some of their towers for Band 41 ahead of merger approval, then this opportunity could have significant value to both Sprint and T-Mobile, particularly in the growth markets described above. A carrier aggregated (with Sprint’s 2.5 GHz LTE Band 41) T-Mobile in less densely populated areas poses a real threat to Verizon and AT&T.
Finally, there was a much discussion over the heated competitive environment, especially with cable (as a reminder, Xfinity Mobile and Spectrum Mobile accounted for ~550K net additions in 4Q). When pushed by Craig about their interest in possibly providing wholesale solutions to cable companies, Mr. Legere responded “In the New T-Mobile, we have a real interest in growing the wholesale side and the retail side of the business. So, we’d entertain it. Absolutely. And we’ve indicated that as well through the process.” No surprise there, and, if cable could pull off a true “best network in your neighborhood” core control strategy and make money, they might pull off the ultimate “other people’s assets” coup.
Bottom line: T-Mobile continues momentum, benefitted by a “bottoms up” strengthening economy, excellent network deployments, and improved segment marketing. Their challenge in 2020 will be keeping net additions in balance (defending metro, building suburbs, launching rural) amidst any Sprint integration efforts. The options facing New T-Mobile are incredible, but their standalone alternative is not a bad fallback.
Verizon’s 4Q: Growth-Driven Margin Pressures Alleviated by Cable MVNO Revenues/ EBITDA
Verizon was one of the first telecom companies to report earnings, but their earnings story needed to be coupled with Disney+ subscriber gains in the quarter to really make sense (the 26.5 million subscriber figure was reported on Tuesday). As we noted in Ronan Dunne’s CES presentation here, the Disney+ growth was likely to have an impact on Verizon’s 4Q costs.
Here’s a consolidated view of the wireless segment:
Service revenues grew $332 million versus 4Q 2018 and just over $2 billion for the full year. Based on the numbers we showed for Charter and Comcast (who had 549K net additions for 1.5 months at $27/ sub per month), these two MVNOs likely contributed $21-23 million sequential (3Q to 4Q) revenue growth (which was desperately needed for Verizon since wireless service revenues for the Consumer segment decreased $88 million sequentially, likely pressured by re-rating of the base to lower unlimited plan pricing).
The impact of cable becomes even stronger, however, when you consider the annual service growth ($2 billion from 2018 to 2019 shown above). Assuming the same $26-27/ sub per month and an average sub basis, cable likely contributed $250-260 million of the $2 billion figure. 13-14% of total growth may appear to be small, but it’s highly profitable because it’s mostly data (Verizon backs this up in their 3Q 10-Q commentary on Consumer Segment growth drivers – see page 49 of the linked doc). Assuming that 65% of this revenue growth drops to the EBITDA bottom line, a full 31% of segment EBITDA growth for the formerly known Verizon Wireless segment is coming from two customers. And, as we have discussed several times, the cable value proposition begins to diminish after the second line in a family plan unless they are low usage (< 2 GB), and there are very minimal SMB cable wireless or enterprise gross additions at the moment. Verizon is threading the cannibalization needle as carefully as possible.
Bottom line: Verizon exits 2020 with a cable MVNO business generating just over $1.0 billion in run rate revenues and ~$650 million in EBITDA (3.134 million customers * $27/ customer per month * 12 months). This business should grow to 4.8 million customers by the end of 2020 (@ $26/ month) and generate an additional $600 million in revenues (and ~$375 million in EBITDA).
The other notable figure in the schedule above is the net equipment subsidy (for 4Q 2018 it was $307 million and in 4Q 2019 it was $484 million). Verizon got aggressive in the quarter on trade-ins. Based on our iPhone sales analysis (outlined in several TSBs in Oct, Nov and Dec), this appears to have been balanced between 5G Android devices and the recently launched Apple iPhone 11, 11 Pro and 11 Pro Max. This move, combined with the Disney+ consumer promotion, likely drove the large increase in retail postpaid gross additions (consumer + 4.1% over 4Q 2018; business up 11.7%).
The real disappointment is Verizon’s broadband performance. Consumer had paltry 1.2% growth in combined FiOS + broadband growth (+149K). This contrasts to Comcast’s 5.2% growth (+1.3 million). Business performed even worse, with -9K FiOS + broadband losses yr/yr, compared to Comcast’s +89K. The fiber being deployed for improved 5G coverage cannot come soon enough. Hans Vestberg indicated that we will be hearing more about their One Fiber initiative in their upcoming Investor Day this Thursday – it needs to be both informative and programmatic (not one-off successes).
Due to space constraints, we will continue the Verizon discussion as it’s the most interesting network transformation story we have seen in the last decade. There’s a lot to prove.
A Brief Comment on Government Investment in 5G Equipment Companies
There were many eyebrows raised over Attorney General Bill Barr’s comments suggesting that the US government should take a more active role to ensure financial success of alternatives to 5G equipment makers Huawei and ZTE. Here’s an extended quote from the end of his speech (full transcript here):
“Now, there have been some proposals that these concerns could be met by the United States aligning itself with Nokia and/or Ericsson through American ownership of a controlling stake, either directly or through a consortium of private American and allied companies. Putting our large market and financial muscle behind one or both of these firms would make it a far more formidable competitor and eliminate concerns over its staying power or their staying power. We and our closest allies certainly need to be actively considering this approach.
“Now, recently there has been some talk about trying to develop an OpenRAN approach, which aims to force open the RAN into its components and have those components be developed by U.S. or Western innovators. The problem is that this is a pie in the sky. This approach is completely untested and would take many years to get off the ground, and it would not be ready for primetime for a decade, if ever. What we need today, as I said, was a product that can win contracts right now, a proven infrastructure, one that will blunt Huawei’s advance.
“As a dictatorship, China can marshal an all-nation approach – the government, its companies, its academia, acting together as one. We’re not able to compel this. When we have faced similar challenges in the past, such as World War II and Russia’s Cold War technological challenge, as a free people we rallied together. We were able to form a close partnership among government, the private sector, and academia, and through that cooperation we prevailed and the challenges we have met. Unfortunately, the cooperative bonds and sense of purpose we were able to muster in the past are harder to call on today. And in the 1950s, we had the Sputnik moment to help galvanize the nation and bring unity to our response, and we have not seen a similar catalyst today.
“If we are going to maintain our technological leadership, our economic strength, and ultimately our national security in the face of this blitzkrieg, we need the public and private sectors to work together and come shoulder-to-shoulder.”
This is some powerful talk coming from the Attorney General of the United States, and spurs some additional thoughts and questions:
- How did we get here? Specifically, why did the US Government approve the sale of Lucent Technologies to Alcatel in 2006?
- Is the transition from 4G to 5G (New Radio) the key concern (where the technology “puck” is today) or is the transition from 4G to 5G standalone the real opportunity? How do these two alternatives look to Nokia (which bought Alcatel-Lucent in 2015) and to Ericsson? Are they willing to embrace a 5G standalone world today?
- In the bigger scheme of things, is the US better off promulgating OpenRAN now (make this our 2020s Sputnik) and developing a US-based competency versus relying on our Nordic allies? (See this Wall Street Journal article which describes recent activity involving AT&T, Microsoft, Dell and others).
- Is the device ecosystem ready for 5G? Do we need a little time for the technology to develop before a lasting solution can be available?
- How do Cisco, Intel, Mavenir and others participate? Are they the collateral damage of picking market leaders Nokia and Ericsson?
I will let AT&T CEO Randall Stephenson’s Friday comments from his interview with CNBC close this week’s discussion on the topic:
“Governments taking positions in private companies to develop private solutions – I just don’t think it’s a good idea. I don’t think the track record of that is very good. I think the [OpenRAN] development is going rather well… Use innovation, use software to win. Don’t use government mandates to win.”
Next week, we will focus on the Samsung Galaxy announcement (Tuesday), Altice USA’s and CenturyLink’s earnings (Wednesday), and Verizon’s Investor Day (Thursday). Who knows, maybe Judge Marrero will render a ruling by the 14th (that would likely be a “box of chocolates” ruling for T-Mobile, Sprint, DT and Softbank)? Until then, if you have friends who would like to be on the email distribution, please have them send an email to firstname.lastname@example.org and we will include them on the list.
Have a great week – and congratulations to the Kansas City Chiefs, Super Bowl LIV champions!