Some of the big attractions for investors in the telecom industry are hefty dividend yields. Market leaders Verizon (VZ 0.49%) and AT&T (T +0.42%) offer dividend yields over 5%.
Meanwhile, the smaller T-Mobile (TMUS +0.28%) doesn't pay a dividend at all. The company has been plowing cash into the business over the last half decade in an attempt to catch up with Verizon and AT&T in terms of network quality, retail footprint, and customers.
Its efforts have paid off, as it's captured nearly all of the postpaid phone net subscriber additions over the last few years. (Those are the most valuable wireless subscribers.) But as the company's investments slow down, its cash-generating capabilities should explode. Management is guiding for 45% to 48% annual growth in free cash flow from 2017 to 2019. But investors shouldn't expect T-Mobile to start paying out a dividend with all that cash anytime soon.
Image source: T-Mobile.
T-Mobile investors don't want a dividend
During the company's second-quarter earnings call, CFO Braxton Carter suggested the carrier could start paying out a dividend in the near future. The growth in free cash flow, he noted, should result in about $10 billion in net cash generation by the end of 2019. "With that amount of cash, we're actually starting to have conversations about instituting a small quarterly dividend that we can grow in the future," he told analysts during the call.
But after surveying T-Mobile investors, management found there wasn't much interest in a dividend, Carter revealed at the Goldman Sachs Communicopia Conference. "We're taking that off the table for the time being," Carter said.
Indeed, T-Mobile's strong growth over the past few years has naturally attracted growth investors. Dividend investors interested in the telecom space are more apt to buy shares of Verizon or AT&T, which are established cash flow machines that consistently raise their dividends year after year.
T-Mobile investors want to see cash reinvested in the business. Management has had a lot of success investing capital so far, attracting millions of new high-value customers. But as T-Mobile's revenue grows and its investment opportunities shrink, more cash is set to hit T-Mobile's balance sheet. That said, Carter plans to continue looking for investment opportunities wherever they may arise. But T-Mobile shouldn't let billions in cash sit on its balance sheet while free cash flow continues to climb significantly higher every year.
So, what's T-Mobile to do with all that cash?
Instead of paying a dividend to shareholders, Carter suggests management could return that cash to shareholders through a buyback program. A buyback presents a key advantage over a dividend in the form of flexibility.
A buyback authorization isn't a commitment like a dividend declaration. If a good investment opportunity crops up in a couple years, T-Mobile could divert funds from the buyback program. Halting or cutting a dividend would have a significant negative impact on the stock, but slowing down share repurchases may not even be an issue.
Both AT&T and Verizon use a combination of dividends and share repurchases to return capital to shareholders. That provides both the wiggle room necessary to make strategic investments and still raise their dividends year after year despite periods of intense competitive pressure.
Carter believes T-Mobile stock is currently undervalued both relatively and absolutely. As such, a share repurchase is "the highest and best use of the money," he said. With free cash flow set to grow quickly starting this year, Carter indicated the share buyback authorization "could be as soon as next year. ... It's something that's more near-term than long-term."
If T-Mobile can keep up its torrid pace of adding new subscribers, increase its average revenue per user, and improve its operating margin thanks to its increasing scale, a share buyback would provide an even bigger boost to the company's earnings per share. Considering analysts already expect average annual EPS growth greater than 20% over the next five years, plans for a share buyback make the stock seem particularly attractive.
