T-Mobile sees growth explosion as recipe for profit

While its subscriber growth was impressive, the company posted a loss. CNET digs into the numbers and explains why T-Mobile is still feeling upbeat.

T-Mobile CEO John Legere
T-Mobile CEO John Legere. T-Mobile

The "Uncarrier" remains unprofitable, but T-Mobile's executives believe they are setting the foundation for change.

T-Mobile has already proven it can add new customers -- in a spectacular fashion. The nation's fourth-largest wireless carrier by subscribers pummeled its larger competitors, gaining 2.4 million net new customers, or more than the other three combined and roughly 12 times the number of consumers added by the next best company, AT&T.

T-Mobile, however, paid the price for that growth, swinging to a first-quarter loss and posting adjusted profits and margins that fell below analysts' estimates. It's a trend that continued from the previous quarter, as its discounts and aggressive offers took their toll on the bottom line.

T-Mobile executives don't seem to be worried.

"We're investing in the future," Chief Financial Officer Braxton Carter told CNET on Thursday. "It's an investment in the short term."

Why is T-Mobile confident? The company likes the kind of customers it was able to attract in the period. While steep discounts suggest bargain hunters, the carrier was able to sign on subscribers with higher credit rating scores, which led to the adoption of more expensive plans and pricier smartphones, as well as drove lower turnover and stable revenue. Ultimately, T-Mobile hopes that leads to a return to the black.

"These are people who are high-quality prime customers choosing T-Mobile at a greater rate than before," said T-Mobile Chief Marketing Officer Mike Sievert.

Wall Street seems to buy the argument; T-Mobile's shares rose $2, or 6.7 percent, to $31.25 in Thursday trading.

It's natural for a wireless carrier to take a hit to its profits in a quarter when customer growth surges -- there is a cost of acquiring the customers in the form of subsidies paid out to cover smartphones.

But T-Mobile doesn't offer contracts or subsidies -- its costs are rooted in discounts and its offer to cover early termination fees. But unlike AT&T and Verizon, which reliably post profits -- even if they sometimes take a hit -- there's still some uncertainty with T-Mobile, which is only a little more than a year into its Uncarrier push.

"You have to dig beneath near-term metrics to determine whether individual customers are being added under economically attractive terms," said Craig Moffett, an analyst at research firm MoffettNathanson. "In this case, they are."

High-quality numbers

Digging deeper beneath the headline number of 2.4 million, T-Mobile added 1.3 million postpaid customers, or the kind of high-quality consumers that Sievert was boasting about. Going a little deeper, a vast majority -- 1.26 million -- signed up for smartphones.

That's an important stat, because smartphone customers still bring in the lion's share of revenue, as the most expensive plans are tied back to the devices. CEO John Legere touted that his company had captured virtually all of the industry's phone growth.

While he is correct, you wouldn't be able to tell that from looking at its rivals' financial results, which have all been reported in the past two weeks. Verizon Wireless boasted of adding 549,000 net retail customers, while AT&T added more than 1 million customers.

But a vast majority of the growth came from tablets or other connected devices. Strip that out, and AT&T added only around 100,000 phone customers, while Verizon actually lost customers in the period. Remove the tablets from Sprint, and it lost three-quarters of a million phone customers.

"To date, Verizon subscriber trends have held up well despite the onslaught from T-Mobile...However, this quarter, AT&T responded on pricing and Verizon's trends suffered as a result," New Street Research analyst Jonathan Chaplin said after Verizon's results last week.

While the carriers would point to those numbers as legitimate growth, revenue from tablets and connected devices aren't as significant, and are considered lower-quality numbers by analysts.

T-Mobile, meanwhile, only added 67,000 tablets -- a slight decline from the fourth quarter -- but is hopeful following its offer of 1 gigabyte of free data to tablet customers.

"We want to continue very strongly in the phone business and grow considerably in tablets," Legere said. "It's not a way to fill in the hole with cheap numbers."

Reason for hope

T-Mobile's projection for 2014 net customer additions of 2.8 million to 3.3 million suggests a bit of a slowdown for the rest of the year, and that might actually be a good thing for its bottom line.

There's an advantage to front-loading the subscriber growth and allowing the residual benefits to trickle down through the year, according to Carter.

The company's full-year forecast for adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $5.6 billion to $5.8 billion suggests it expects growth -- it only reported adjusted EBITDA of $1.1 billion in the first quarter.

Carter said there were a few other factors that would contribute to profitability. The company in March increased the price of its unlimited data plan to $80 a month. It also curtailed corporate discounts, a controversial move that angered existing members. (T-Mobile ended up keeping the discounts for existing customers, but nixed it for anyone new.)

He also said there would be additional merger-related savings costs from the integration of prepaid carrier MetroPCS that would benefit results in the second half.

Carter, however, declined to say when the company would return to a profit.

Need for scale

While T-Mobile may be on the rise now, Legere noted that Verizon and AT&T, which remain far larger, could technically wait it out and use their superior scale to eventually squeeze it out.

The wireless business, as its industry executives love to say, is a scale business. It cost billions of dollars to deploy and maintain a network, particularly when dealing with a country as large as the US. Over time, that gap between T-Mobile and its larger rivals would start to show up.

sprinthear.jpg
Will Sprint and T-Mobile merge? Regulators don't think so. Sarah Tew/CNET

That's Legere's justification for why there should be more consolidation in the wireless industry.

"We've always said ultimately, it's a consolidation game and a matter of when, not if," he said.

He said consolidation would be a positive thing now, and might be less beneficial down the line if AT&T and Verizon grow even more dominant.

That's as close as he got to commenting on the persistent rumors that Sprint wants to acquire T-Mobile.

T-Mobile, curiously, may have hurt its own chances of a deal with its strong results. In killing AT&T's attempt to buy T-Mobile in late 2011, regulators said they preferred four national players in the industry. T-Mobile's resurgence ultimately proved the regulators correct that all four could survive in the market together.

Regulators have signaled that they would be against a deal between Sprint and T-Mobile, but at least one analyst can see the benefits.

"As far as long-term viability of the strategy, one need only look at how much EBITDA Verizon and AT&T generate and the capital that they invest in their network to see how a combination with Sprint would increase the ability of T-Mobile to be even more competitive in the future," said Walter Piecyk, an analyst at BTIG Research.

Chasing the Uncarrier

While AT&T and Verizon acknowledged some pressure, the carriers said that the recent promotions enacted late in the first quarter were helping, and they both saw their performance improve toward the tail end of the period.

"If I turned in results like they did, I would be saying those things to build confidence," Sievert said. "It was a tough quarter for them."

T-Mobile had launched its own string of offers earlier this month, including the capped budget plan and the offer of free data, potentially as a countermeasure to some of the discounts offered by its rivals.

Legere said he wasn't done.

"We definitely have an idea for Uncarrier 5.0 and 6.0," he said. "There are a couple of areas we know that consumers really want to see a change in."

He said the moves wouldn't necessarily have the same kind of financial impact as its Uncarrier 4.0 early termination fee buyout program, which will likely come as a relief to anyone watching that bottom line.

About the author

Roger Cheng is the executive editor in charge of breaking news for CNET News. Prior to this, he was on the telecommunications beat and wrote for Dow Jones Newswires and The Wall Street Journal for nearly a decade. He's a devoted Trojan alum and Los Angeles Lakers fan.

 

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