With Deal in Sight, We've Raised Our Sprint and T-Mobile Valuations
The merger will create an exceptionally well-positioned wireless carrier.
As we move to a new model that assumes the merger will close shortly, we are increasing our Sprint (S) fair value estimate to $8.20 per share from $7.20 and our T-Mobile (TMUS) fair value estimate to $91 per share from $80.50. We assume that T-Mobile will be able to negotiate a more favorable share exchange ratio than the original agreement. We peg the ratio at 0.09 T-Mobile share per Sprint share, down from 0.103 originally, a level that reflects relative movements in net debt since the merger was announced. The original deal terms would put our Sprint fair value estimate at $9.40 and our T-Mobile fair value estimate at $88. If T-Mobile negotiates a 0.08 exchange ratio, our Sprint fair value estimate will fall to $7.30 and our T-Mobile fair value estimate will rise to $95.
We expect the combined company will generate about $75 billion in revenue during 2020, down from $77 billion in 2019, reflecting postpaid customer growth offset by the sale of Sprint’s prepaid business to Dish. Beyond 2020, we assume that T-Mobile’s integration efforts will be successful, with customer churn steadily declining from the blended levels that the combined company has posted recently. We further assume that the company is able to attract new customers, though with revenue per customer growing only modestly due to T-Mobile’s promises to regulators and competitive pressure. As a result, we forecast wireless service revenue will grow about 4% annually through 2024.
The combined company is likely to report relatively weak margins in 2020 as it ramps up integration efforts. We peg the combined company’s EBITDA margin at about 30% in 2019. Over the next couple of years, we expect this margin will dip into the mid- to upper 20s including integration costs, then expand to about 34% by 2024 as integration costs fade and savings roll in. While this margin expansion may not seem impressive, we assumed that T-Mobile would move away from the phone leasing model. Adjusted for this shift, we assumed 9 percentage points of margin expansion, with the company gaining network, marketing, and overhead savings.
We expect heavy capital spending over the next three years, hitting more than 20% of service revenue, to bring the two networks together. We then expect capital spending to moderate, holding at $10 billion-$11 billion per year thereafter, similar to amounts Verizon has reported in recent years.
While we now believe the merger will close, there’s still a chance the companies will fail to reach a new agreement or some other challenge could emerge. If the deal falls apart, our stand-alone Sprint fair value estimate now stands at about $1 per share, down from $3 previously as the company’s performance has remained weak, especially concerning the pace of customer defections and deterioration in margins. This estimate is imprecise, and we believe Sprint faces substantial risk of a restructuring if left without T-Mobile. Our stand-alone T-Mobile fair value estimate would be $76 per share.
On a combined basis, we believe Sprint could be worth $11.40 per share and T-Mobile could be worth $127 per share in a bull-case scenario. In this scenario, T-Mobile is able to move Sprint customers onto its network quickly and drive postpaid phone churn down to T-Mobile’s current levels within a couple of years. After a brief lull, the company adds postpaid phone customers at the same annual rate T-Mobile managed in 2019. At the same time, revenue per customer growth accelerates as customers demand additional services. Under these conditions, wireless service revenue growth hits nearly 7% by 2024. The benefits of increased scale and lower assumed network costs per customer push the EBITDA margin to 38% in 2024, around levels that AT&T and Verizon enjoy.
On the other hand, the merger may not go as well as planned. In a bear-case scenario, we think Sprint could be worth $5 per share and T-Mobile could be worth $56 per share. In this scenario, we assume customer churn increases and remains high through 2022 as customers become dissatisfied with the network during the transition and rivals aggressively target these accounts. Growth improves beyond 2022, but the company struggles to rebuild its reputation. As a result, its postpaid phone customer base is only slightly larger in 2024 than it is today. We also assume revenue per customer flatlines over the next couple of years as T-Mobile struggles to retain customers. Wireless service revenue growth averages 2% between 2021 and 2024 in this scenario. Heavy network investment over the next several years hurts cash flow and also leaves the company with a more expensive operating expense base. The EBITDA margin in this scenario holds at 30% over the long term.
Michael Hodel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.