The wireless industry is transitioning to a new era. Next-generation 5G networks promise faster speeds, new applications, and greater revenue growth for carriers.
And while those advances require tens of billions of dollars in investment to realize, wireless service is a highly profitable recurring revenue business. That means a lot of free cash flow and the capacity for serious shareholder returns.
Barron's spoke with the chief financial officers of AT&T (ticker: T), Verizon Communications (VZ), and T-Mobile US (TMUS)—plus T-Mobile's president of technology—during the third-quarter earnings season to discuss those opportunities for investors, what metrics to use to track performance, and the case for their stocks.
Investors haven't loved the outlook for wireless companies lately. AT&T stock has lost 7% after dividends this year as the company unwinds its media and telecom conglomerate structure to focus on wireless and broadband. Verizon is pouring funding into its networks and analysts are skeptical of its growth targets. Shares have cost investors 7% after dividends. T-Mobile stock has slid 10% this year; the company has plenty of work left on its integration of Sprint.
The S&P 500, meanwhile, has returned 27% including dividends over the same period.
An edited version of our conversations with the finance chiefs follows.
Barron's: How would you describe the competitive intensity of the U.S. wireless industry today. What's your company's competitive advantage?
Verizon CFO Matt Ellis: Absolutely it's a competitive space. But that speaks to the value that connectivity plays in consumers' and businesses' lives today. We've never been afraid of competition. Competition makes us better.
What gives us the opportunity to win is the quality of our network. It's the reliability, it's the coverage, and the overall experience. Then we give our customers the opportunity to pick the right plan for each individual connection on the account through our Mix-and-Match approach and bring different entertainment options to those plans.
AT&T CFO Pascal Desroches: Competition is intense, but it has always been intense. If you look at our profit margins, they're extraordinary. Others are putting money into this space because of its attractive economics. What is different for us now is we are doing a lot of things well and we're back to the basics. We've organized ourselves more closely to the market and we're targeting segments that are underserved. We are providing consumers more value through a trade-up to a new device and bundling content.
T-Mobile CTO Neville Ray: We've established a multiyear lead in 5G. We're within arm's reach of nationwide coverage in ultra-capacity mid-band. That's literally two years ahead of the public statements from our competition around when they would reach that mid-band footprint [of at least 200 million people covered.]
And we're not standing still. Over the next two years, while Verizon and AT&T are working to catch up to where we are today, we'll continue to build out and expand and upgrade this network for a further 100 million people.
What are your capital allocation priorities?
Verizon's Ellis: The first thing we always do is ask what are the investment opportunities in the business. You've seen us do that with the C-Band license acquisition and allocating an additional $10 billion in capex to build that out as quickly as possible. The pending acquisition of Tracfone, too. All of those are investments in the business that we think will create long-term value for our shareholders.
Putting the balance sheet back in a place where it continues to provide us with optionality is another core priority. And then, of course, returning capital to shareholders. We increased our dividend for the 15th year in a row. And once we've satisfied those three priorities, certainly buybacks are something we'd look to do as well.
AT&T's Desroches: Invest fully in our businesses to ensure that we are well-positioned to grow. There's more investment now than ever because there is a recognition that connectivity—both wireless and fiber—are very attractive businesses. Next, we're going to provide a healthy dividend for our shareholders and continue to delever. Once we get below 2.5 times net-debt-to-earnings before interest, taxes, depreciation, and amortization, we'll look at other ways to generate value for shareholders [such as buybacks.] The spin versus split decision [regarding WarnerMedia] may also help us improve the capital structure of the firm overall.
T-Mobile CFO Peter Osvaldik: Build out our 5G network, the product that all three of us are selling is our network. T-Mobile is already in a fully differentiated 5G position and we're going to keep it that way. So priority number one is the network.
Number two is getting through the integration. There's a host of merger-related costs including, for example, site decommissioning where we have to pay out either immediately or over time the remaining lease payments on sites that we're eliminating. That's tens of thousands of sites ultimately. Those first two things unlock the synergies and massive cash flow that open up the possibility for shareholder returns.
What's the best metric for investors to track your company's performance in the 5G era?
Verizon's Ellis: Start with the top line: wireless service revenue growth. That was up 3.9% in the third quarter and we continue to grow that. It then allows us to grow margin and cash flow. If you just focus on the subscriber numbers, then you have to ask yourself if they are all revenue-paying and so on. But if you look at the revenue number, you can see who's really creating valuable connections.
AT&T's Desroches: Mobility, our largest business, is growing both the top line and bottom line. Our consumer broadband business has reached an inflection point where it is also growing top line and bottom line. Continued momentum in those businesses will be the clearest markers to look for as we move forward. It will result in sustainable cash generation and earnings growth when you couple that with a much better leverage position and a lower but still attractive dividend.
T-Mobile's Osvaldik: I think there are few number ones, honestly. One is account and average revenue per account growth. The second is how quickly we're getting through the Sprint integration. That could be synergy realization, cell site decommission timing—however you want to measure it. And then the third—because it really cuts through the noise—is how we are converting service revenue into free cash flow, which is the ultimate value creation of the business. That's what allows you the flexibility to do stock buybacks or invest in growth opportunities.
Why should investors buy your stock today?
Verizon's Ellis: You get the opportunity to invest in a market leader who has historically built out the largest and highest-margin wireless business in the U.S. We're on the front edge of the next generation of technology as we enter the 5G era. That will open up additional revenue opportunities for us in mobility, with wireless nationwide broadband that's not just in our Fios footprint, and within the B2B space with mobile edge compute and more.
When you add those things together, we've got a great opportunity to drive accelerated growth in the business. You saw that in the revenue guidance we gave at the investor day earlier in the year and we couldn't be more excited.
AT&T's Desroches: We are incredibly attractively priced. Since the new management team has taken over we have performed better than others in the industry. Because of the changes in direction we've had over the last decade, there is a bit of reticence to jump back in, notwithstanding the success. But those two factors should scream that we are very much underappreciated and undervalued and the returns will be very attractive for those who invest. My belief is that, over time, all we can control is our execution. Those who trust us will be handsomely rewarded.
T-Mobile's Osvaldik: Nobody else has the growth opportunities in front of them in this industry that T-Mobile has. Nobody else has the network, which is the product, to be able to defend the areas where we're strongest. And nobody else has the opportunity to deliver free cash flow conversion from service revenue like we do, or have the amount of excess free cash flow to potentially turn to shareholder returns that we do. So it's just a tremendous time in T-Mobile's history for investors to get in.