Event: T-Mobile (TMUS) will report Q4 results tomorrow before the open. The options market is implying about a 5.5% one day move, which is rich to the 4 qtr average one day move of about 3.5%, but shy of its long term average of about 8%.
Price Action / Technicals: TMUS is down about 10% on the year, and down about 20% from its 52 week highs. This is in sharp contrast from peers AT&T (T) and Verizon (VZ) which are up 6% and 8% respectively, while Sprint wallows in the gutter down 25% on the year.
As my friend Cater Worth of Cornerstone Research likes to say, “draw the lines anyway you like, but this is the way I see them”. Well, here you go. I am hard pressed to see TMUS not testing the long term uptrend very soon:[caption id="attachment_61413" align="aligncenter" width="600"] TMUS 5 year chart from Bloomberg[/caption]
Leverage: What separates the performance of this group? likely leverage ratios and credit ratings.
For instance T & VZ’s respective debt to equity sits about 55%, with over $100 billion each on market caps of both a bit over $200 billion. Both saw large increases in their debt load associated with large acquisitions (T of DTV and VZ of Vodafone’s stake of their wireless unit). On the flip side TMUS’s nearly $25 billion debt load is 85% of their market cap, while, Sprint’s debt load is 3x that of its market cap. The only thing TMUS and S having going for them is that Deutsche Telecom and Softbank own 65% and 85% respectively of the two. For all intents and purposes these two companies are back-stopped, but this high debt levels and concentrated ownership could keep potential acquirers at bay.
My View: TMUS’s subscriber gains in the U.S over the last few years have been impressive, as they have gained 8 million subscribers in both 2014 and 2015 (per their pre-announcement in early January). But I suspect these gains in an increasingly saturated and competitive market in the U.S. has hastened the expected decline in wireless pricing. The bluster of CEO John Legere, routinely taunting his larger competitors and punching down at his lesser ones is likely to come back and bite him in the ass at some point.
Just as AT&T bought DTV to increase the network effects of their properties, I suspect the reverse could be of interest for large cable companies as has been rumored. The way I see it, foreign telcos can buy U.S. ones, domestic ones can merge, cable or media companies can buy wireless companies, but it’s all a bunch of nonsense as ultimately they all become unwound. Deustche Telecom bought Washington based Voicestream Wireless for $50 billion in 2000. In 2002 DT created the brand T-Mobile, and in 2007 spun out T-Mobile US. In 2012 it made bid to buy post paid carrier Metro PCS in the U.S. after regulators blocked AT&T’s bid for TMUS, and now DT is considering selling TMUS. Whoah, that was a lot. But you get the point, like most telcos, it’s a big rollup. Some day it will be devoured by larger telco or media company only to be chopped back up.
So What’s the Trade?
Owning a stock for a possible take-over at some point in the future is a tricky game. However, there are a couple ways to do it with options that protects against near term risk in a way that just buying the stock can’t. And just buying an upside call isn’t the best way to do it because you could lose a lot of money on decay waiting around for something that may or may not happen.
We are not playing the stock in anyway ourselves because we’d like to get a sense of the guidance given on the call first. So for those who worry that the year to date under-performance to its peers is meaningful. And worry about future guidance given Q4 and 2015 subs announcement, but think TMUS likely gets bought at some point, then you might want to consider the following trade structures in lieu of stock:
In lieu of 100 shares of TMUS buy the May 30/40 risk reversal
Buy the TMUS ($35.30) May 30/40 Risk Reversal for .30
- Sell 1 May 30 put at 1.00
- Buy 1 May 40 call for 1.30
Rationale – This trade has the risk profile of long stock, but only below $30 and above $40 on May expiration. Therefore it defines an area of normal stock movement in a 10 dollar wide range where there’s essentially no harm, no foul. The goal here is to participate in a sharp move higher on takeover specualtion, without the risk of the stock pulling back slightly. A steep decline in shares below $30 and you are put the stock, so you would need to be willing to own the stock at that level. The most likely odds are that neither the call or the put come into play and 30c was spent for a few months of takeover opportunity.
in lieu of 100 shares of TMUS buy the Feb/May 37 call calendar:
Buy the TMUS ($35.30) Feb/May 37 call calendar for 1.80
- sell 1 Feb 37 call at .50
- buy 1 May 37 call for 2.30
Rationale – This trade fades the near term upside potential on the event itself to position for further upside in the months after. Ideally the stock would go slightly higher in the event, leaving a well financed long May 37 call and a worthless short of a Feb 37 call. Even if the stock went nowhere or slightly lower in the near term you would still be positioned for possible upside through May. The most that can be lost on this trade is what is paid for it, so it’s risk profile is better than that of long stock if the stock gets hit hard in the next few months. There is slight risk to the upside on the event itself as a large gap to the upside above the $37 strike could actually turn what was a bullish trade into a bearish one, but that level is significantly higher where it would be a near term loser and is unlikely.