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2 Hedge Fund Gurus Are Loading Up On T-Mobile -- Should You?

Thursday, February 27, 2014 8:30 AM

We're in the midst of a wireless telecom revolution that promises to save consumers millions of dollars.

The radical new pricing strategies adopted by wireless industry laggard T-Mobile (NYSE: TMUS) have led to all-out price wars, and things may only get worse for key rivals -- and better for consumers.

T-Mobile's aggressive pricing strategies aren't merely a gimmick to rattle the competition: They're aimed at building sales and profits. After digesting just-released fourth-quarter results, analysts now expect the carrier to boost revenue roughly 10% to 12% this year to around $29 billion. Operating cash flow is now expected to move up around 25% to 30% this year, to around $4.6 billion, according to consensus forecasts.

And the company is starting to get the attention of hedge fund managers, many of whom like to own companies that have a chance to shake up an industry. Third Point's Daniel Loeb bought 7.6 million shares in the fourth quarter of 2013 at an average price of $27.41. And Leon Cooperman (who I profiled a year ago) also established a fresh 3 million-share position at the same buy-in price as Loeb.

Here's the unusual thing: This stock traded under $10 in the summer of 2012 and was still below $15 a year ago. These two fund managers chose to buy in long after the stock had begun to rally.

Though shares have risen roughly 10% since their buy-ins, these fund managers likely see much more upside. The question is: Are they right to expect that? If so, it's not too late for you to ride their coattails to potentially robust upside.

Make no mistake, this is a kind of company that Wall Street analysts typically hate. To win customers, T-Mobile is providing massive incentives, such as its offer to pay early termination fees imposed by rivals.

Flickr/StockMonkeys.com
After digesting just-released fourth-quarter results, analysts now expect T-Mobile to boost revenue roughly 10% to 12% this year to around $29 billion.

Such moves pressure margins in the short term. As a result, analysts recently lowered their 2014 forecasts for earnings per share (EPS) and earnings before interest, taxes, depreciation, and amortization (EBITDA).

Of further concern, the company is throttling back spending on its network. Recall that Sprint (NYSE: S) underinvested in its network, which led customers to flee to the better networks of Verizon Communications (NYSE: VZ). Management at T-Mobile is clearly betting that its network is "good enough" and need not be state of the art. Consumers, in search of a bargain, seem to agree.

Here's what else such moves as fee termination payments do: They garner a huge amount of loyalty. Even if rivals follow suit and announce a similar program, T-Mobile has already established itself as the consumer's friend. That's no mean feat in an industry that's known for treating consumers badly.

Another positive: The company has found that customers taking advantage of the fee termination offer tend to have high credit quality, according to analysts at Credit Suisse.

Even as investors take note of positive signs in just-released fourth-quarter results, the current quarter is expected to show an even more dramatic impact. Based on industry commentary, analysts think rivals will lose a combined 1.4 million customers this quarter, while T-Mobile will add 1 million. On a full-year basis, management expects to add between 2 million and 3 million new customers, almost all of which are defectors from rivals.

That kind of momentum explains why analysts have largely left 2015 and 2016 EBITDA and EPS forecasts intact, even as margin assumptions have moved lower. "T-Mobile has emerged as an aggressive share-taker far sooner than expected," note analysts at UBS.

Where To From Here?
T-Mobile has a chance to be seen as a unique operator in an increasingly commoditized business, and CEO John Legere likely has more clever tricks up his sleeve. Loeb and Cooperman clearly believe that this is a company with a multi-year runway to growth.

Meanwhile, shares are not yet expensive despite the recent run-up, trading for less than 6 times projected 2015 EBITDA. EBITDA growth is coming from operating synergies as T-Mobile and the acquired Metro PCS network start to converge into one platform.

Risks to Consider: Despite the good news, there is reason for caution. As rivals lose more customers, they will have to increase their competitive response, which may start to blunt T-Mobile's momentum. That's great news for customers, but it threatens to push the entire industry onto a lower profit margin plane.

Action to Take --> Most analysts have price targets that are only a few dollars above current levels. Canaccord Genuity is at the high end of Wall Street, with a $39 price target. Though UBS' analysts see shares rising to just $34, they also think shares could reach $42 if strong revenue growth is maintained in 2015 and network management expenses continue to decline.

One thing's for sure: T-Mobile's rivals should not be seen as bargains right now. As I noted in September, they've been a favorite target of short sellers. AT&T (NYSE: T), with 150 million shares currently held short, is the single most heavily shorted stock on the New York Stock Exchange. Verizon is the sixth most shorted company; Sprint is 13th. Don't look for a short squeeze, either, as these companies look poised to lose more market share in 2014.

T-Mobile is a company with clear operational momentum, and though shares have pulled back roughly 10% since the year began, further upward momentum is likely to continue as robust quarterly growth rates continue to roll in.

P.S. Stocks owned by investing "gurus" like Daniel Loeb and Leon Cooperman are just one of the criteria StreetAuthority's Michael J. Carr looks at when deciding what to recommend in his premium advisory Guru Trader. The system he's perfected during his 26-year trading career not only screens for stocks owned by investing "gurus" like George Soros, Carl Icahn and Warren Buffett -- but it actually tells him what to buy and when to buy and sell. To learn more and get his next "guru trade" in your inbox, click here now.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of T in one or more of its “real money” portfolios.