Nomura Sees Varying Strategies in the Telco Space Amid Modest Growth; AT&T (T) and T-Mobile (TMUS) Named Top Pick

Jeffrey Kvaal from Nomura initiated coverage on the Communication Services sector and noted big changes between the major players in this mature industry. Top picks are AT&T (NYSE: T) and TMobile (NASDAQ: TMUS).

The four largest telcos face modest industry growth, now even in mobile. Their reactions, each informed by pivotal events in corporate history, vary widely. Verizon (NYSE: VZ) and AT&T are broadening into video, though with the most opposing strategies in memory. Insurgents Sprint (NYSE: S) and T-Mobile can grow, and TMUS has grown, via share gains. They favor synergy story AT&T and insurgent play T-Mobile over Verizon and Sprint.

Little organic growth but higher barriers to entry protect FCF. Along with high penetration rates and slowing wireline businesses, they see little scope for material industry sales growth. They see little imminent threat to the incumbents' FCF and, thus, consider dividends safe.

Incumbents pushing into linear video via widely different means. AT&T’s seminal $63bn DirecTV deal makes it the U.S. leader in linear video. The company is priming for a slow shift from linear to mobile video from an incumbent spot. By contrast, Verizon signaled its view of a brisk shift via its $130bn Verizon Wireless deal.

Incumbents are unlikely to lower prices, leaving room for insurgents. The firm's checks indicate neither AT&T nor Verizon is likely to lower mobile tariffs. Thus they believe T-Mobile and Sprint have scope for ongoing share gains.

• AT&T (Buy, $39): Cash flow growth through M&A synergies. They expect DirecTV synergies to more than offset modest share loss and subscriber erosion in mobile and video. They expect modest video subscriber erosion and steady upward revisions to EPS and dividends.
• T-Mobile US (Buy, $48): The little engine that still is. T-Mobile vaulted beyond its failed AT&T deal into a market share gainer. They expect its share gains and EBITDA expansion to continue, given limited competitive response. They consider T-Mobile’s 6.1x EV/EBITDA multiple undemanding.
• Verizon (Neutral, $47): Visibility beyond a sideways 2016 is limited. Verizon’s leading mobile network and crisp execution should ensure financial stability. However, it offers a clouded 2016 EPS growth story and low visibility into new growth drivers beginning in 2017.
• Sprint (Neutral, $4): Recovery not yet enough to look past funding gaps. After SoftBank’s investment, improving network quality and innovative pricing have placed Sprint on the brink of a true revival story. However, the resulting balance sheet strain, chiefly from capex, may prove too severe.

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