By Seerat Sandhu (Scripps College), Charlie Solnik (California Polytechnic State University), Cameron Caldwell (University of Glasgow), Michelle Santoso (University of Edinburgh), Shannon Keegan (Wake Forest University) and Chirag Gupta (NYU Stern)
Overview of the Deal
T-Mobile issued $19 billion worth of bonds in April 2020, via a private offering in the second-biggest bond sale of this year. The proceeds from the sale will help close the company’s merger with Sprint after a two-year-long approval process. At issuance, the bonds were in high demand, with investors placing approximately $75 billion of orders. The interest reflects a general consensus that the telecom sector is low risk due to a high position in consumer priority payments.
The company’s debt offering was broken down in five parts, all of them in the form of investment-grade, senior secured bonds, and managed by Barclays Plc, Deutsche Bank AG and Goldman Sachs Group Inc. Of the $19 billion worth of bonds, the majority ($7 billion) is generated from the aggregate principal amount of its 3.875% Senior Secured Notes due 2030. The remaining $12 billion is distributed amongst five to thirty-year securities ranging from 3.5% to 4.5% Senior Secured Notes.
The Senior Secured Notes are rated “BB” by S&P and BB+ by Fitch, with the latter correcting its Long-Term Issuer Default Rating (IDR) of T-Mobile to BB+ from BB in April. The correction reflects the improvement in T-Mobile’s reputability as an issuer following the closing of its merger with Sprint.
Macroeconomic Trends
Unlike the Aviation and Hospitality Industries which have been hard hit due to COVID-19 and the resulting market shocks, the Technology and Telecommunications Industries have emerged relatively unscathed from the onslaught of the pandemic. In fact, the many stay-at-home orders and strict social distancing standards have emphasized the need for virtual proximity. A combination of video conferencing platforms and digital services have filled the void of human interaction and seen a surge in demand. Furthermore, with college classes and business meetings being conducted through online channels, there has been a tremendous boost in data consumption due and rising demand for connectivity. Consequently, companies like T-Mobile, Verizon and AT&T have benefitted and monetized over the growing data and connectivity needs. Hence, it is not surprising to note that although most bond sales in the past quarter of 2020 have been correlated towards the generation of funds to mitigate repercussions of the coronavirus pandemic, T-Mobile’s debt offering is unique as the issuance does not reflect any pandemic-related headwinds.
The Telecommunications Industry is undergoing rapid technological shifts to widen its reach. Deloitte in its 2020 Telecommunications Outlook labelled 2020 as the year of 5G. Over 1,000 companies in the sector were expected to begin developing 5G technology by year end before the onset of the COVID-19 pandemic. The deployment of 5G will allow telecom companies to expand their services beyond data distribution to provide services such as network slicing. It will also increase both download speeds and monthly data capacity for the unlimited-data plans being offered by the Telecom companies. Because the players in the Telecom Industry are also the carriers of internet connectivity, they are bound to play a role in the implementation and spread of The Internet of Things (IoT) - one of 2020’s major telecom trends. This will enable the companies to reduce downtime for their networks and help monitor data centres year-end more effectively. Artificial Intelligence (AI) plays a crucial role in the Telecom sector for network optimization and maintenance. With 5G and IoT increasing the number of devices connected to their respective networks, the network providers are expected to rely on AI for data security purposes.
In terms of the bond market, Investment-grade corporate bond yields have been decreasing and the Fed has been purchasing higher rated bonds for the first time. The Fed has taken these measures to support credit markets during the pandemic.
Company Details
T-Mobile US is a wireless cell-phone service provider for 86 million customers, offering wireless devices and accessories in addition to communication services. T-Mobile began as a spinoff of Western Wireless called VoiceStream in 1994 before being acquired by Deutsche Telekom in 2001 and renamed to T-Mobile USA. T-Mobile recently merged with Sprint Mobile to become one of the largest cell service providers in the US.
Founded in: 1994
Headquartered in: Bellevue, WA
CEO: Mike Sievert
Number of Employees: 52,000
Market Cap: $143.6 billion
EV: $207.2 billion
LTM Revenue: $44.996 billion
LTM EBITDA: $13.088 billion
LTM EV/Revenue: 4x
LTM EV/EBITDA: 13x
Current Ratio: 1.1
Table 1: Current Capital Structure of T-Mobile (Capital IQ)
Bond Details of T-Mobile
Table 2: Credit Ratings of T-Mobile (Capital IQ)
S&P downgraded T-Mobile’s credit rating following the company’s merger with Sprint, with its issuer-credit rating and rating on T-Mobile's senior unsecured debt rating falling from BB+ to BB. Currently, the rating outlook for T-Mobile is stable, reflecting a belief that the expected cost synergies from the merger will likely be offset by various integration expenses and higher attrition for the Sprint network. This could mean limited free cash flow and EBITDA growth. Moody’s predicts free cash flow will break even in the first year and expects free cash flow will increase slowly from that point on, with meaningful growth potential in the third year and beyond.
Table 3: Bond Structure of T-Mobile (Capital IQ)
Projections and Assumptions
Why was this deal done?
The primary motive behind the $19 billion bond issuance by T-Mobile has been to fund its acquisition of Sprint. The bond offering would allow T-Mobile to repay a majority of the $23 billion debt which it has obtained via a bridge loan by 16 banks to help finance the M&A deal. After the repayment of $19 billion, the company would keep a $4 billion seven-year-term loan on its balance sheet. Funding of the Sprint acquisition would thus help T-Mobile to build a bigger and better wireless network and enhance its existing 5G network through synergies between both companies.
Short-term Analysis
The funds obtained from the offering have enabled the completion of the T-Mobile Sprint merger, thus allowing T-Mobile to overtake AT&T to become the second-largest US carrier with 98.3 million US subscribers. The company has exceeded Moody’s April 2020 projection of T-Mobile reaching a competitive subscriber basis to AT&T following the company’s merger with Sprint. The funds have also presented the company with an opportunity to scale further by offering customers multiple deals on new plans. T-Mobile’s rollout of rate plan offers and heavy advertising has allowed the company to achieve a record-low 3.52% branded prepaid churn in Q1 2020, down 33 bps year-over-year. The company offered a plan in which customers would spend as little as $25 a line for four lines of unlimited everything, including nationwide 5G data, thereby undercutting Verizon and AT&T.
T-Mobile, which has been expanding its 5G network coverage, succeeded in becoming the first (and only) network provider to have a presence in all 50 states because of its pre-existing partnership with GCI as of June 2020.
Apart from its efforts to boost 5G coverage, the cell phone carrier has been redesigning its organizational structure to further pull forward synergies. With its long time CEO John Legere stepping down, the company is radically re-defining its previously set brand image. In a similar vein, T-Mobile announced lay-offs for hundreds of Sprint employees, despite the company’s initial claims that the merger would create jobs instead of eliminating them. The laid-off employees are to get severance packages worth around two weeks’ pay for each year worked on the job. The company has created around 200 new job openings and has announced a hiring initiative to add around 5,000 new jobs in areas such as Business, Retail Care and Engineering over the next year. Under the terms of the transaction, Sprint shareholders will receive a fixed exchange ratio of 0.10256 T-Mobile shares for each Sprint share or the equivalent of approximately 9.75 Sprint shares for each T-Mobile share.
Long-term Analysis
Over the next six years, T-Mobile is expecting its capacity to increase 14x over what they have today. This implies that data streaming and utilization will be even better for streaming, gaming, downloading and any other content. The company is also expecting their network to be 8x faster than the current LTE in a span of few years, and 15x faster in the next six years. T-Mobile and Sprint claim they will be able to provide 5G network coverage to 99% of Americans. This expansion will help bring data connectivity to even the rural parts of America. If T-Mobile is able to deliver on its growth estimates, the increased scale would significantly boost the company’s long-term competitive position in the telecom industry. Such an increase in scale has the potential to propel T-Mobile into a market leader position. While those estimates forecast a bright future for T-Mobile, the long-term performance of the company ultimately relies on their ability to turn around some of Sprint’s problematic assets, which have historically underperformed.
Efficient use of technology such as reduction of redundant cell sites and rapid deployment of the spectrum and other technologies will shape the synergies achieved from the merger. The Un-carrier has the potential to give competition to the Big Cable through the provision of a replacement of the in-home broadband. T-mobile’s wireless in-home broadband will help provide additional coverage to previously difficult to cover areas in the long-run. Within the next six years, it will deliver 100+ Mbps speeds of wireless broadband to a majority of the American population via its in-home services.
Financial Ratio Analysis
Table 4: Financial Ratios of T-Mobile (Capital IQ)
All profitability ratios have dropped over the last twelve months. This demonstrates T-Mobiles profits have been impacted as a result of the loss of business due to the pandemic
Gross Margin remained constant reflecting that cost of goods sold has remained on an upward trend throughout the pandemic and that T-mobile's supply chain has remained resilient throughout the pandemic
The cash position of T-Mobile is stable (a positive levered free cash flow margin) and this is recovering from a negative ratio several years earlier
T-Mobile's current ratio for the last twelve months sits at 1.0, demonstrating T-Mobile has just enough current assets to cover its debts. There is potential this could drop more if further debt needs to be issued. However, this is a better position than in previous years
The debt/equity ratio is high, signifying T-mobile uses debt to finance its growth and are fairly capital intensive in their spending
Risks and Uncertainties
With the number of COVID-19 cases and stay-at-home orders on the rise, people have been scrambling to take shelter at home. This pandemic-induced rise in data consumption poses technological risks for Telecom companies. T-Mobile suffered from an IP traffic-related issue followed by a backup failure which led to dropping of 20% of T-Mobile’s calls for a day in the month of June. Such technological issues could have negative effects on consumer subscriptions.
In 2019, the Technology and Telecom Industry was already facing concerns from both the public and the authorities in terms of data security. This concern over data security has further amplified with increasing Antitrust issues and impending investigations for tech companies both big and small. The expected rise in demand for data security and increasing reliance on artificial intelligence to curb the same poses additional technological risks.
Although the US wireless industry is expected to be a low-risk industry in the pandemic owing to its integral nature, yet it is not immune to the spillover effects of the pandemic. The effects of the pandemic on household income and rising unemployment could prove to be unfavourable for companies such as T-mobile. As per Fitch, the exposure of T-mobile and Sprint to sub-power borrowers was 47% and 42% respectively at the end of 2019. Under such conditions, deteriorating economic conditions could contribute to a rise in service terminations and defaults in financing plans.
The company’s merger with Sprint poses yet another set of business-related risks. The past few years, Sprint’s network had a material underperformance when compared to competitors, which could easily limit the company’s growth potential in the coming years. T-mobile has to absorb Sprint's historically problematic assets, underperforming network and customer decline. The company could experience a fall in operating cash flows if the costs of the merger outweigh the future benefits. Apart from this, the T-mobile Sprint merger has brought additional scrutiny over the actions of the company. Post-merger, the companies have been making efforts to set a new combined brand image and any minor incompetency has the power to tarnish the newly formulated brand image. With COVID-19, the increase in T-Mobile’s retail stores might prove more costly than expected as cautious customers are moving to online shopping. A fall in the brand’s image would mean a negative subscriber trajectory and ultimately contribute to a fall in investor confidence.
Will they be able to repay?
T-Mobile enjoys an insulated position amidst the coronavirus pandemic owing to its integral position in the Telecom Industry. Furthermore, the company’s acquisition of Sprint has enabled it to further strengthen its operations. Not only has the company’s credit ratings and debt position improved as compared to its previous levels, but it has also emerged as America’s second-largest network service provider. Although the company faces certain risks pertaining to increasing scrutiny over data security and the many costs of its integration with Sprint, the company’s ability to repay its debt obligation remains positive.
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