T-Mobile (NASDAQ: TMUS) has been on a tear over the last few years, winning the lion's share of postpaid phone net subscriber additions in the industry. Those gains have come largely at the expense of AT&T (NYSE: T) and Verizon (NYSE: VZ).
Continue Reading Below
T-Mobile has been extremely aggressive with its Un-carrier moves, many of which have been extremely attractive to consumers but harmed industry economics like its move to unlimited data plans. As a result, its EBITDA margin sits well below those of AT&T and Verizon.
Management has big plans to grow free cash flow over the next few years. But in order to do so, it has to take care of its biggest disadvantage.
"Our disadvantage all along has been scale," CFO Braxton Carter told investors at a recent conference. "And to achieve the margins that are possible to be achieved in the U.S., we have to have that scale."
What's T-Mobile doing to reach scale?
As of the end of the third quarter, T-Mobile had about 33 million postpaid phone subscribers and 20 million prepaid subscribers. In comparison, AT&T has about 64 million postpaid phone subscribers and 14 million prepaid subscribers. Verizon doesn't break out postpaid phone subscribers, but has nearly 110 million postpaid connections on its network and nearly 6 million prepaid subscribers.
Continue Reading Below
Despite its recent success, T-Mobile is still small compared to the two market leaders. That's why it's repeatedly shown interest in merging with Sprint (NYSE: S), which is even smaller than T-Mobile.
Over the last couple years, T-Mobile has taken steps to improve its network, expanding it into markets where it doesn't even have a retail presence. This year it's rapidly building out retail locations in new markets. Carter says the effects of these new storefronts can take up a year to show up in terms of subscriber additions.
T-Mobile is also dead last in terms of enterprise customers. AT&T has nearly twice as many business subscribers as it does consumer subscribers, and the gap is growing wider as the business segment cannibalizes consumer customers. Carter says T-Mobile will apply similar Un-carrier initiatives to the enterprise market as it did for the consumer market to drive subscriber growth.
The upside for AT&T and Verizon
With the wireless service market in the United States near saturation, T-Mobile's growth will have to come from somewhere, especially now that a merger with Sprint is off the table. AT&T and Verizon are most likely to cede customers to T-Mobile simply because that's where most customers are today.
But Carter noted that scale would allow T-Mobile to become less aggressive with its consumer pricing and promotions. After all, T-Mobile needs to expand margins in order to show the significant cash flow growth it's aiming for over the next couple years. That means less margin pressure on AT&T and Verizon as well.
While a merger with Sprint would have been more beneficial for AT&T and Verizon, T-Mobile already seems to have plans to reduce margin pressure going forward.
AT&T seems resigned to sacrificing low-margin subscribers to T-Mobile, and Verizon has managed to withstand the onslaught of pressure from T-Mobile relatively well recently. Considering AT&T's concentration of enterprise customers, investors can expect that trend to continue as T-Mobile shifts its focus to enterprise customers. But improving scale at T-Mobile should produce better profits for the entire industry.
10 stocks we like better than T-Mobile US
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and T-Mobile US wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 6, 2017