T-Mobile (NASDAQ: TMUS) has led the United States wireless industry in subscriber growth over the last four years. Offering customers things like separate equipment billing and reintroducing unlimited plans destroyed some of the favorable economics enjoyed by much larger carriers like AT&T (NYSE: T), but it's allowed T-Mobile to quickly scale the size of its business.
Meanwhile, AT&T has expanded its operations by acquiring DirecTV and WarnerMedia (formerly Time Warner). Wireless is still its biggest business, but the company is leaning on bundling television content with its wireless service in order to improve subscriber retention.
The two companies are starkly different despite each being one of just four major U.S. wireless carriers. If you had to buy just one, which should it be -- AT&T or T-Mobile?
Image source: Getty Images.
AT&T spent a lot of money...for what?
AT&T spent $49 billion on DirecTV and another $85 billion on WarnerMedia. It's also made a few other small acquisitions in the meantime, leading it to pile up over $180 billion in debt.
But it's not clear these acquisitions bring much to the table.
The addition of DirecTV made AT&T the largest pay-TV provider in the country. That gives it better negotiating power against media companies, saving it some money. AT&T has taken to aggressively bundling television service with its wireless service in order to improve retention. That hasn't worked out very well, as AT&T still lost 570,000 postpaid phone subscribers in 2017. Still, management claims customers who bundle exhibit noticeably better retention than non-bundlers, so it may have been much worse without the bundled offerings.
The acquisition of WarnerMedia gave AT&T access to a lot of content. It could save some money for AT&T in terms of negotiating carriage rates for WarnerMedia's television networks, but the cost savings would come mostly from its own pocket. AT&T is already the largest pay-TV provider in the nation; it could have used that leverage to negotiate better rates instead.
The one potential area of growth for AT&T is moving television advertising into the digital world. The combination of DirecTV, WarnerMedia, and AT&T's existing customer relationships with tens of million of consumers gives it an opportunity to innovate on television advertising and improve targeting and returns for marketers. There are still some roadblocks in the way, and the traditional television audience continues to shrink, so it's not clear how valuable a new television ad product could be for AT&T.
T-Mobile: can it keep up the pace?
T-Mobile has been growing like gangbusters over the last four years or so, but subscriber growth is already starting to slow. Postpaid phone net additions slowed to 617,000 in the first quarter this year, compared to 798,000 in the first quarter last year and 877,000 the year before. Indeed, T-Mobile seems to have shifted its focus, at least to some degree, from growth at all costs to improving cash flow. The company expects to reach $4.5 billion to $4.6 billion in free cash flow next year, up from $1.4 billion in 2016.
Most importantly, T-Mobile's pending deal to merge with Sprint (NYSE: S) would help solve most of the company's shortfalls against AT&T. Both smaller carriers notably suffer from a lack of scale, which means they have higher costs per customer than bigger carriers like AT&T. The combined company would be about the same size as AT&T's wireless operations, which should enable it to produce profit margins in line with AT&T's wireless business.
A successful merger would certainly improve profitability, but T-Mobile's reinvigorated brand strength and improved wireless network ought to enable it to keep growing its subscriber base, albeit at a continually slower pace. That said, it's still adding more subscribers than every other carrier. Investors should expect continued margin improvement, but a merger would move the needle a lot faster.
T-Mobile is also dipping its toes into the pay-TV market with the acquisition of Layer3 TV at the end of last year. Layer3 delivers linear video programming over household internet connections similar to various other streaming services, including AT&T's DirecTV Now. Its current product is more of a premium product like regular DirecTV, but T-Mobile is planning to launch a nationwide service, which may offer skinny bundles -- one of the few areas of growth for pay-TV. It's not clear exactly how T-Mobile plans to integrate Layer3 with its wireless service, but it only paid $325 million for it -- chump change compared to AT&T's acquisitions.
So, which is a better buy?
AT&T is getting bloated and making acquisitions with stock and debt when it already has the leverage to negotiate superior content licensing agreements. It does have a lot of potential to improve television advertising for the entire industry, but there are still a lot of question marks. That puts it in a precarious situation.
T-Mobile, meanwhile, is seeing slower subscriber growth, and it's banking on a successful merger with Sprint to stay competitive and improve profitability. Its Layer3 acquisition still poses some questions as well, but the operations seem much stronger.
Looking at the valuation of both companies might help crystallize which is the better buy.
Data source: Yahoo! Finance.
T-Mobile and AT&T have strikingly similar valuations. Considering the growth potential for T-Mobile and the potential for a successful merger with Sprint, I'd rather own shares of T-Mobile than AT&T.
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