Loeb Has the Right Position and Waits for a Potential Merger

Activist investor Daniel Loeb (Trades, Portfolio) added T-Mobile US Inc. (TMUS, Financial) at a price of $25. It makes me feel that he is betting that the company could be acquired by Sprint Corp. (S, Financial) or Dish Network Corp. (DISH, Financial). So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity.

Strategic Acquisitions

In 2011, AT&T (T, Financial) announced plans to acquire the company for almost $40 billion. At the end of the year, AT&T agreed to pay only $4 billion to T-Mobile and enter into a roaming agreement. Moreover, in 2012 T-Mobile US and MetroPCS announced a merger between them. The deal synergies were expected to be in the range of $7 billion to $8 billion, also with geographic expansion of the MetroPCS brand.

Loeb´s hedge fund, Third Point LLC, has a stake in SoftBank Corp., the wireless carrier that owns Overland Park. If SoftBank combined Sprint with T-Mobile, this could lead to a $20 billion or $30 billion cost savings. Although Verizon Wireless and AT&T focus on the premium segment of the market, the Sprint and T- Mobile merger will generate a stronger competitor for them. Third Point’s chief executive officer said that “the combination of Sprint and T-Mobile creates the only real counterbalance to a decade-long market- and profit-share grab by the industry’s two largest players.”

Reversing Losses

The industry is facing huge technological advancements with progress in digital signal processing and transmission technologies. Due to the iPhone era T-Mobile produced good operating results. Last year the company was able to reverse the results of the two previous years thanks to the postpaid customer growth. Looking forward, the firm has a great challenge in the investment arena, towards the development of new applications.

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 119.98x, trading at a premium compared to an average of 17.2x for the industry. To use another metric, its price-to-book ratio of 1.9 indicates a discount versus the industry average of 2.2 and the price-to-sales ratio of 0.94 is below the industry average of 1.4. The last metrics indicate that the stock is undervalued relative to its peers.

Earnings per share (EPS) increased in the most recent quarter compared to the same quarter a year ago. Also, it has demonstrated an upward trend over the past 10 years which is a good signal. We include in the next graph the stock price because EPS often lead the stock price movement.

Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has slightly increased when compared to its ROE from the same quarter one year prior. This is a signal of strength and could be attractive for investors. Furthermore, it is higher than competitors such as Sprint and Clearwire Corp. (CLWR, Financial).

Final Comment

Third Point was likely attracted by T-Mobile’s takeover prospects, as well as its improving operating performance and relative valuation compared with its peer group as we have seen before.

For a long-term perspective, I would advise fundamental investors to consider adding T-Mobile to their portfolios as its M&A have the potential to offer much faster mobile Internet speeds.

Hedge fund managers have also been active in the company. Gurus like Michael Price (Trades, Portfolio), Richard Pzena (Trades, Portfolio), Larry Robbins (Trades, Portfolio), John Paulson (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio) have invested in it.

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Disclosure: Damian Illia holds no position in any stocks mentioned.

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