Activist Investor Criticizes T-Mobile Over Accounting

Image source: T-Mobile.

Un-carrier T-Mobile (NASDAQ: TMUS) is finding itself on the receiving end of some accounting criticism. Activist investor CtW Investment Group has asked that the SEC look into T-Mobile's accounting practices, alleging that the company did not adequately disclose a change in one of its most important estimates: allowance for credit losses. CtW believes that T-Mobile has been quietly reducing this allowance, which is a percentage of equipment installment plan (EIP) receivables, even as the credit quality of those receivables has been "deteriorating." CtW estimates that the change allowed T-Mobile to book an additional $122 million in earnings between Q4 2014 and Q3 2015.

In addition, the investor says T-Mobile has been given inappropriate prominence to non-GAAP financial metrics, a practice that the SEC started broadly cracking down on earlier this year. Deutsche Telekom, as the majority shareholder and parent company, also stands to benefit from the possible accounting discrepancies, which CtW says has helped T-Mobile shares soar to all-time highs. Deutsche Telekom also recognizes a portion of T-Mobile's earnings on its own income statement.

Let's take a look at CtW's allegations and see if investors should be concerned.

Why so low?

Here are the four quarters in question (emphasis CtW's):

Data source: CtW. Figures in millions.

Note that the large drop in EIP receivables at the end of 2015 was due to T-Mobile selling some of the receivables. T-Mobile uses a "proprietary credit scoring model" to evaluate customer credit quality, using numerous factors like credit scores and other profile characteristics. The company then categorizes its EIP receivables as either prime or subprime, and further discloses how much is due under each category. CtW notes that while T-Mobile reduced its allowances as a percentage of receivables, the proportion of subprime customers was actually increasing.

Image source: CtW.

The $122 million in increased earnings that CtW estimates is based on the difference between the allowances that T-Mobile recognized over those four quarters and what it would have recognized if it had used an allowance of 2.8% (the lowest level set in Q1 2014).

To GAAP or to non-GAAP, that is the question

In May, the SEC issued guidance to companies on how to appropriately present non-GAAP financial metrics. Specifically, GAAP metrics should be presented first and take prominence over non-GAAP metrics. T-Mobile has failed to do this on a few occasions since the guidance was given.

CtW says that T-Mobile excludes spectrum licenses from its calculation of adjusted free cash flow, which doesn't make sense since spectrum is a critical part of the business and quite expensive, to boot. The basis of the allegation is unclear, as in T-Mobile's earnings releases the reconciliation provided adds back decommissioning payments related to shutting down MetroPCS' CDMA network. All of MetroPCS' spectrum has been refarmed and integrated into the T-Mobile network at this point.

Investors aren't fazed

Some of CtW's allegations seem to hold some water. The reduction in allowances relative to receivables does appear a little suspicious, and it did translate into an increase in revenue recognition. Allowances for credit losses directly reduce the amount of revenue that is recognized on the income statement. Whether or not T-Mobile can justify the reduction based on internal data that isn't disclosed in its filings remains to be seen, but it's possible there's a legitimate explanation.

The issues around non-GAAP disclosures are easily remedied as well, as it's mostly an alteration with how companies disclose adjusted figures. Since the SEC only issued its guidance about six months ago, it will take some time for companies to change their ways to comply. For the most part, investors appear unfazed by CtW's letter, as shares are essentially flat in trading today.

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