Some investors and analysts have become increasingly concerned about T-Mobile's (NYSE:TMUS) ability to maintain its free cash flow trajectory even as the carrier has aggressively built out its network footprint and grown its subscriber base. But skeptics may not be seeing the big picture, according to MoffettNathanson.
In an extensive research note, the analyst firm noted that the nation's third-largest wireless operator declined to offer guidance on its free cash flow during its most recent earnings call, citing uncertainty over incentive auction spending, growth momentum and concerns about the costs of equipment installment plans (EIPs) and handset leasing. But for this year, at least, T-Mobile's primary factors determining free cash flow will be EBITDA, capital expenses and interest expense. "And while we don't have management guidance for beyond 2016, consensus at least broadly agrees on the longer term ramp rate for each," the firm observed.
Instead, MoffettNathanson said the uncertainty stems from changes in working capital. "The complexities of leasing, installment financing, and factoring have led to wide divergences between sell-wide working capital estimates. The huge range of estimates suggests that many are simply modeling it wrong."
Indeed, T-Mobile's shares have outperformed the broader market by 36 percent, according to the firm, but "momentum has seemingly stalled" during the past nine months, with shares seemingly trading in-line. Much of that surely can be attributed to doubts that the carrier can continue its tremendous momentum in an increasingly competitive market where even the dominant operators offer consumers two-for-one deals on top-of-the-line handsets and hundreds of dollars to switch. But concerns about bad debt and valuation have also contributed.
When considering T-Mobile's free cash flow over the coming months, though, investors should look first at its ARPU, which began to fall when the carrier began selling phones rather than subsidizing them. The decrease was due in part to accounting practices but also was "a consequence of a bona fide price war that peaked in 2014" when AT&T finally moved to EIPs, MoffettNathanson said. ARPU has also declined due to Data Stash, the carrier's service plan that includes month-to-month rollover of unused data under certain conditions. But the ARPU slide will continue to slow this year as effects from the price war wane and Data Stash has less of an impact because "the base will largely be already penetrated" under the program, lessening its ongoing impact.
Other factors are in T-Mobile's favor as well, MoffettNathanson said, even if they aren't obvious to investors. The firm said consensus estimates for its EBITDA "are way too high" due largely to erroneous assumptions regarding the mix of leasing versus EIP plans, and that financial models of working capital are sometimes fundamentally misunderstood.
"The free cash flow story at T-Mobile is every bit as compelling as the footprint expansion one," the firm concluded. "T-Mobile remains our top pick in Telecom."
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