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Morningstar | T-Mobile’s 3Q Was Solid, but Not as Strong as the Numbers Indicate; FVE Remains $76

T-Mobile U.S. delivered solid third-quarter results, though not as strong as the numbers would indicate at first glance. Hurricane costs a year ago, insurance receipts this year, and accounting changes provided a lift to both revenue growth and margins. The firm continues to capture market share in the postpaid segment, slowly grinding away at the scale disadvantage it faces versus Verizon and AT&T. The proposed Sprint merger remains the most important event facing T-Mobile over the near term, but we believe gauging the prospects for regulatory approval remain difficult.

We are leaving our $76 fair value estimate and no-moat rating unchanged; we view T-Mobile as roughly fairly valued on a standalone basis, with upside should the Sprint deal go through.

Reported services revenue increased 5.7% year over year, a significant slowdown versus the past several quarters (in the 6%-8% range). Stripping away the benefits of an accounting change and hurricane impacts, growth slowed even more sharply to about 4.7%. On the positive side, T-Mobile added 774,000 net new postpaid phone customers during the quarter, up nicely from 595,000 a year ago. While growth in the phone customer base has slowed relative to the 2014-2016 period, the firm continues to handily outperform Verizon and AT&T. On the downside, average revenue per postpaid phone customer declined 1.6% on a reported basis, marking the sixth consecutive year-over-year decline. In addition, prepaid customer additions were the weakest in five years (35,000), even as average revenue per customer drifts lower.

T-Mobile management views “flattish” revenue per customer in 2018 as a welcome trade-off for penetrating customer segments it hasn’t traditionally attacked, including business accounts, seniors, and military families. Record low postpaid customer defections seem to bear this out: phone deactivations declined 10% year over year despite 9% growth in the customer base.

Slowing the rate of defections should provide a strong lift to profitability, but that hasn’t happened yet. The reported EBITDA margin increased to 28.4% from 27.0% a year ago, though this difference is again inflated. Stripping out insurance reimbursements and accounting benefits, the EBITDA margin would have declined to 26.4% while hurricane costs knocked more than a percentage point off the margin a year ago. This result makes sense considering the aggressive investments T-Mobile is making in its network and customer service operations, but also reflects the scale disadvantage the firm faces as it attempts to maintain growth momentum five years into a remarkable run of success.