We are calling an audible on our 2021 purchase of AT&T (T).  We have sold the shares and reinvested the proceeds into T Mobile USA (TMUS).  We still see value in T shares.  However, we see more upside in TMUS.  Furthermore, we see the TMUS story playing out over a multiyear period vs. AT&T being a fixer upper over the next year.  Northlake has typically used a buy-and-hold approach with individual stocks, often holding investments for five years or more.  Finally, we think the positive fundamental investment thesis we see at TMUS has more visibility than the positive outlook we have for T.  The bottom line is we believe TMUS offers more upside at a higher degree of confidence.

Given our interest in cable and telecommunications, we have followed TMUS closely for many years.  The company’s rise as an insurgent from third or fourth in wireless to a market leader and full peer of AT&T and Verizon has been very impressive.  TMUS shares were trading at just $15 back in 2013 and are up 757% since then.  Verizon shares have a total return of 60% over the same period, while AT&T is up only 5%.  AT&T and Verizon have paid out healthy dividends, while TMUS does not pay a dividend but investors have clearly recognized the superior growth profile and operating execution at TMUS.

The next phase of the TMUS story is just getting started.  Following years of market share gains as the Uncarrier that made TMUS a strong #3 in wireless and produced superior earnings and free cash flow growth, the 2020 acquisition of Sprint made TMUS a full peer of AT&T and Verizon.  Subscriber counts and geographic coverage moved to parity and TMUS emerged with a stronger spectrum position concentrated in the most efficient mid-band range.  TMUS is able to offer 5G broadly today, while AT&T and especially Verizon had to spend heavily on new spectrum just last year.  The spectrum was extremely expensive and Verizon will not have it fully online for nationwide 5G for another year or two.

While TMUS’s improved and arguably superior competitive position has been evident for a couple of years, the real payoff is about to occur when earnings and free cash flow explode higher.  The integration of Sprint has been a massive job and not without hiccups.  When we bought T shares last July, TMUS was trading around $150 vs. our new purchase price of $121.  Much of that decline was due to higher-than-expected churn within the Sprint customer base.  In its 4Q21 earnings report issued in January, TMUS made clear that churn had peaked and what happened in 2021 was just an acceleration of their internal forecast.  With the combined subscriber base now well established (and still dominating industry growth), attention turns to the final step of the billing integration that should be completed in mid-2022.  At that point, free cash flow will flow as massive cost synergies exceed their hefty cost to capture.  Consensus forecasts call for TMUS free cash flow to rise from $5.6 billion in 2021 to $13.5 billion in 2023.  Management has long promised a huge stock buyback program in 2023.  The confident tone from management on the 4Q21 conference call about churn and net synergies give us confidence that the buyback will arrive ahead of schedule later this year. 

We think the buyback announcement will be a big positive catalyst for TMUS shares.  In addition, with the Sprint integration almost complete, we expect the next couple of quarterly reports to mimic the positive results seen in the 4Q21 numbers.  The earnings reports should improve sentiment toward the shares with the buyback still to come. 

We believe TMUS shares have upside to $150 this year, a gain of 25%, based on 8X EBITDA and recognition of the 2023 free cash flow.  Once initiated, the buyback should be large and ongoing.  TMUS could easily buy back half or more of the stock float (Deutsche Telecom owns over 40% and is not a seller) from 2023 through 2025 while maintaining a healthy balance sheet.  We have four decades of experience investing in stocks that offer above average organic growth, large and growing free cash flow, and material share buybacks.  The payoff has always been superior.  Perhaps this time is different, but we think the recent collapse in the stock of unprofitable growth stocks suggests this tried-and-true approach to creating shareholder will once again be in vogue.

TMUS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.