T-Mobile (TMUS -0.06%) recently delivered solid results for the first quarter of 2023, with earnings per share rising by 177% year over year to $1.58, and coming in ahead of expectations. While the U.S. telecom posted a slight revenue decline, that entirely had to do with negative-margin device-related revenue. However, core services grew by 3% while postpaid subscription revenue grew by 6%. That growth, on top of moderating costs and merger synergies from its 2020 acquisition of Sprint, pushed free cash flow higher by a whopping 46%.
As a result, management raised its full-year guidance for postpaid net additions, adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization), and free cash flow.
And yet, T-Mobile's stock fell slightly after earnings, pulling back from the $150 per share mark.
There may be a specific reason T-Mobile's stock has such trouble crossing the $150 mark in particular, and it may have nothing to do with the company's operating results. Here's why the stock may be "stuck" below $150 per share for a while, but why there may be a silver lining for long-term shareholders.
An overhang from Softbank
The $150 per share threshold is a specific line of demarcation outlined in a 2020 deal with Softbank (SFTB.Y -0.12%), which was made at the time T-Mobile closed its Sprint acquisition.
During the two years when T-Mobile and Sprint were going through their deal process, Sprint's operating results deteriorated. Therefore, when the deal closed, Softbank, which owned a large stake in Sprint at that time, agreed to forfeit 48.8 million shares of T-Moble it would have been entitled to in the deal -- essentially, taking less in the acquisition. However, per the deal terms, Softbank will be able to recoup those 48.8 million shares if T-Mobile's 45-day volume-weighted average price (VWAP) exceeds $150 per share before the end of 2025.
While T-Mobile's stock has crossed $150 for days at a time, its VWAP hasn't yet exceeded that amount for the required 45 days.
On the most recent earnings conference call, one analyst actually asked the question of management: Since the stock can't seem to get over $150, despite solid operating results, would management consider an alternative deal with Softbank to "clean up" the overhang?
Of course, there would be a cost associated with buying out Softbank, and CEO Mike Sievert said in response: "[I]t's not lost on us why you're asking the question. If there ever was to be a transaction, it has to be something that would work for everyone." Sievert then went on to note that since T-Mobile started its share repurchase program in September, it has already repurchased more shares than the 48.8 million that would go to Softbank if the option is triggered. T-Mobile has repurchased 59.4 million shares for $8.5 billion since September, at prices that average out to around $143, which is close to where shares trade today.
Image source: Getty Images.
Are institutional investors selling at $150?
It is hard to know what exactly is driving any stock's price in the short term, but there does appear to be some resistance to T-Mobile's shares around the $150 mark. Perhaps institutional investors are selling shares there, as they fear the dilution that would occur if the shares spent too long above $150, which would hurt the stock price.
But there is a point beyond which keeping shares below that level wouldn't make sense. With 1.2 billion shares outstanding as of April 21, those 48.8 million shares only equate to about a 4% dilution to the stock, or about $6 per share. So, if an institutional investor believes the stock is worth more than $156, it wouldn't make much sense to sell at $150 over fear of this dilution.
The stock is currently trading at around 12.8 times the midpoint of this year's free-cash-flow guidance range. There is a case to be made that T-Mobile is fairly valued here, but that's only valid if it doesn't grow much.
However, T-Mobile has grown consistently for years, and now with Sprint's 5G spectrum, it has the broadest 5G coverage of any carrier, with the opportunity to take market share in under-penetrated rural markets, business accounts, and wireless broadband. Most onlookers (and company management) seem to think there's more growth ahead. The average analyst price target is around $180.
Speaking of buybacks
Last quarter, it was interesting that management used even more cash for share repurchases than the company made in free cash flow, taking on incremental debt to fund share buybacks. When asked about the repurchases, Sievert said:
... generally speaking, we're going fast because we think we're getting a relative great deal on the stock. And it's not normal for management to talk a lot about valuation, but since, you know, you've hired us to conduct this buyback on your behalf, we have to make operating decisions with an idea in mind about whether or not we're getting a relative value. And our team thinks and our board thinks it is. And so, we have authorized moving quickly because we look at this rapidly developing cash flow picture, and a lot of people are increasingly valuing T-Mobile on our value relative to cash production. And we see a lot of potential ahead for a diminishing opportunity for us to be able to grab shares at these share prices. And so, we're moving really fast.
If management thinks shares are a great deal in the $140s, then it may not be the worst thing if T-Mobile's stock stays below $150 due to this overhang. After all, management has projected it will spend $60 billion in repurchases through 2025, of which it has already spent $8.5 billion.
That remaining $51.5 billion would equate to 30% of the company at these prices. Moreover, large stakeholder Deutsche Telekom (DT -0.35%) recently increased its ownership in T-Mobile to over 50%, and it doesn't appear to want to sell anytime soon. That means if T-Mobile executes its repurchase program at these prices, it could retire over 60% of the company's publicly traded free float in just two and a half more years.
For long-term investors, that wouldn't be the worst scenario. Should the stock not exceed $150 before 2026, it could march materially higher after that point. After all, Softbank would be denied its shares, and T-Mobile's share count would be much lower.
However, I don't think the stock will stay below $150 for that long. T-Mobile is executing well, aggressively buying back stock, and trades at a below-market valuation. Eventually, I see the stock marching above the $150 threshold consistently in the next two years, and Softbank getting its shares. However, as a long-term shareholder, either scenario would be fine with me.
