We think T-Mobile stock (NASDAQ: TMUS) is currently a better pick compared to Verizon stock (NYSE: VZ). This is despite the fact that TMUS is currently trading at a P/S multiple of 2.7x, quite high compared to 1.8x for Verizon. Does this gap in valuation make sense? The contrast is not a whole lot better when you see the last twelve months (LTM) operating margins of Verizon which stand at 22%, more than double that of TMUS’ 10%. In addition, operating margins in the last twelve months have increased 3.4 percentage points for Verizon as against TMUS’s 1.9-point decrease. Then why is there a mismatch of the multiples?
T-Mobile’s better P/S multiple is a reflection of superior revenue growth over the years. The stock shot up after the company’s merger deal with Sprint received regulatory approval. This has helped T-Mobile add 5.5 million postpaid customers in 2020, the most it has ever added in a year. On the other hand, though Verizon’s revenue size is much larger, the y-o-y growth is less. Also, Verizon’s operating margins (though higher than TMUS) have remained volatile over the years, while TMUS’ margins have seen continuous growth between 2016-2019. TMUS stock has been able to maintain investors’ interest mainly because of healthy subscriber and revenue growth expected in the coming quarters, led by acquisitions and 5G expansion. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical Revenue Growth as well as Operating Income and Operating Margin growth. Our dashboard Verizon vs. T-Mobile has more details.
1. Revenue Growth
Between 2016 and 2019, Verizon revenues increased 4.7% from $126 billion to $131.9 billion, mainly due to growth in the wireless segment. In comparison, T-Mobile revenues increased 20% from $37.5 billion in 2016 to $45 billion in 2019. Growth was driven by increase in both, postpaid as well as prepaid connections. Revenue growth in the last twelve months for TMUS has been an impressive 34%, while Verizon’s stood at -2.3%. Such a wide difference was mainly due to the merger of Sprint and T-Mobile which helped TMUS expand its customer base. Verizon on the other hand has been focusing on organic growth, which was affected to a certain extent due to the pandemic.
2. Operating Income
Verizon’s operating margins have constantly remained close to 2x that of TMUS. But VZ’s margins have seen a steady decline between 2016-2018 from 23% to 17%, while they went up in 2019 only to be at their 2016 level of 23%. Contrast this with steady improvement in TMUS’ operating margins from 7% in 2016 to 12.7% in 2019. This rise was mainly driven by operating cost efficiencies and lower cost of equipment. Though both companies saw a decline in margins in the last 12 months, the drop in the case of TMUS was slightly more due to merger-related expenses.
The Net Of It All
Although Verizon’s revenues and margins in absolute terms are much more than that of T-Mobile, TMUS’ growth is far higher. The company is expected to improve this revenue growth rate significantly going forward due to its merger with Sprint in 2020. This has helped T-Mobile add 5.5 million postpaid customers in 2020, the most it has added ever in a year. In comparison, Verizon has added 1.6 million retail postpaid customers in 2020. This tells us that TMUS is continuing with and is, in fact, improving on its customer addition and revenue growth rate and narrowing the gap with Verizon. Also, TMUS’ recent deal with Brookings Municipal Utilities (BMU) to acquire BMU’s Sprint-branded wireless assets will help TMUS expand its customer base even further in 2021. TMUS is expected to cumulatively add close to $35 billion to its revenue base in 2020 and 2021 (growth of 75%-80% compared to 2019).
A sharp rise in revenue is likely to offset the near-term drop in margins due to spending on 5G expansion, thus benefiting investors with superior earnings. Verizon’s weak customer additions will take a toll on its stock price in the near term, while T-Mobile’s continuous growth will provide further fillip to its stock. Thus, we do not see the gap in the P/S multiple (1.8x vs 2.7x) between these two telecom giants narrowing anytime soon. Instead, even with a higher multiple, TMUS looks like a better opportunity at the moment. As per T-Mobile valuation by Trefis, we have a price estimate of $145 for TMUS stock while Verizon’s valuation works out to $62.
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