The U.S. telecom industry is facing intense competition. The biggest culprit in the fierce landscape is T-Mobile (TMUS 0.47%), which has taken steps to undermine the status quo of the wireless industry and provide real competition for stalwart AT&T (T 1.30%). T-Mobile's efforts have helped it grab millions of new customers over the past four years. Meanwhile, AT&T is bleeding valuable postpaid phone subscribers.
While the net addition numbers may be impressive for T-Mobile, AT&T controls a huge share of the market. Its scale provides tons of cash flow, which has enabled it to make huge acquisitions such as DIRECTV while distributing a hefty dividend.
Let's take a closer look at both companies to see which stock makes a better buy.
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T-Mobile is the growth company in telecom
T-Mobile is the only one of the four major wireless carriers that's growing service revenue. Last quarter, the company increased 8.1% year over year. For comparison, AT&T's service revenue declined 2.5%.
That growth is fueled by net additions, which are up 6.5 million across postpaid, prepaid, and wholesale channels. Most impressive is its postpaid phone subscriber growth (3.4 million), which T-Mobile estimates is the entire industry's net subscriber growth.
Meanwhile, average revenue per user was ticking higher but fell modestly in the second quarter. T-Mobile recently started including taxes and fees in its pricing and promised never to raise rates for existing customers, which could slow growth. It's been moving customers toward its unlimited plan, and it recently raised the price of its top-tier plan to help offset the trend.
Management expects strong operating income and free cash flow growth over the next three years. From 2016 to 2019, it expects operating income to grow an average of 15% to 18% per year and free cash flow to grow 45% to 48% per year on average. That indicates that the company is ready to start pulling back on its aggressiveness. After building out its storefront footprint and its recently acquired 600 MHz spectrum, investors can expect T-Mobile to exhibit better cash flow and returns on capital.
Penetrating markets where it has little to no retail presence remains an opportunity, but customer growth is already starting to slow. T-Mobile should remain the fastest-growing telecom in the industry, but it won't match the same level of growth as the past four years.
AT&T is getting even bigger
While its postpaid wireless subscriber base is shrinking -- it hasn't added customers since the third quarter of 2014 -- AT&T is still becoming a bigger company. It acquired DIRECTV in 2015, and it's set to close its acquisition of Time Warner later this year.
With the DIRECTV acquisition, AT&T is using it to bundle video service with its wireless service with the aim of increasing subscribers for both. AT&T has three video services now -- U-Verse, DIRECTV, and DIRECTV NOW -- and it offers $25 any one of them to its unlimited data plan customers. It's throwing in free HBO, a Time Warner property, for its top-tier customers.
It's not clear the bundle is working. As mentioned, AT&T is losing postpaid phone subscribers, and it's losing video subscribers as well. Last quarter, the company lost 199,000 video subscribers. The losses would have been worse without the 152,000 new DIRECTV NOW subscribers. Those subscribers are generally lower value than U-Verse and DIRECTV customers. Time Warner could help improve margins for its entertainment division thanks to improved cost efficiencies with content rights negotiations.
The biggest advantage AT&T has is its scale. Scale enabled it to generate a wireless EBITDA margin of 41.8% in the second quarter. That compares with just 29.5% for T-Mobile. AT&T's free cash flow over the past 12 months totaled $15.8 billion. T-Mobile has negative free cash flow of nearly $5 billion during that same period. That allows AT&T to pay out a hefty dividend, which currently yields about 5.2%.
So, which is a better buy?
T-Mobile is still a great growth story, and if it succeeds in its plans to expand its retail and network footprint, it should continue to produce strong growth for years to come. Its network is closing the gap with the top players, and it has several million potential customers that it doesn't even serve yet. After its expansions, it should be able to start generating meaningful operating income and cash flow.
AT&T is still a huge cash-generating machine. If you're looking for a healthy dividend that's relatively safe, AT&T is a good buy. If you couldn't care less about dividends and you're focused on growing businesses, T-Mobile is a better buy.
