In previous analyses, I recommended Deutsche Telekom (OTCQX:DTEGF/OTCQX:DTEGY) as a good bond substitute. Despite the dividend cut, I predicted, investors were able to achieve a decent dividend yield this year (the company only pays a dividend once a year). The average dividend yield of the last 12 months was approximately 4.5 percent.
In the medium term, the 5G expansion and the T-Mobile US (TMUS)-Sprint (S) merger, in particular, will place a financial burden on the company. However, the company is well-positioned to withstand both. Regarding the merger between Sprint and Deutsche Telekom’s subsidiary T-Mobile US, an exciting opportunity has now arisen for Deutsche Telekom, which the company is taking full advantage of.
The previous setting
In 2018, Sprint and T-Mobile US announced their intention to merge. At that time, Deutsche Telekom held just over 60 percent of the shares in T-Mobile US. Sprint was a subsidiary of the Japanese holding company SoftBank (OTCPK:SFTBF, OTCPK:SFTBY). After the merger was completed, Deutsche Telekom was to hold around 42 percent of the shares of T-Mobile, while SoftBank was to keep 27 percent. A first smart move by Deutsche Telekom was that the company secured several privileges against SoftBank.
- Although the company was to hold less than 50 percent of the shares in T-Mobile US after the merger, it secured the majority of votes with a voting agreement.
- Deutsche Telekom has also built in a security interest in the event that SoftBank wants to sell its T-Mobile US shares. Deutsche Telekom can veto such a sale for four years.
- Deutsche Telekom has also secured a right of first refusal.
For me, as a Deutsche Telekom investor, the merger thesis was valid:
The companies expect synergies with a cash value of around USD 43 billion and an enterprise value of approximately USD 150 billion. More importantly, the merger would create new growth opportunities for T-Mobile US. T-Mobile US has experienced extreme organic growth and it was foreseeable that the company would no longer be able to grow on its own with the same growth rate. The new merged company would be closer to the two market leaders and would have a 29.6 percent market share in the USA.
In the meantime, however, things have changed, and it looks as if Deutsche Telekom will emerge from the merger as the clear winner.
What has changed now
First, Deutsche Telekom was able to indirectly lower the price of the Sprint shares through subsequent contract negotiations. Deutsche Telekom’s stake was increased to 43 percent for the same price, and the SoftBank stake was reduced to 24 percent.
But after SoftBank speculated with some expensive investments in Tech Start-Ups (such as WeWork (WE) and Uber (NYSE:UBER)), it became clear that the company urgently needs money. For this reason, SoftBank intends to sell company stakes worth USD 40 billion, of which USD 20 billion are T-Mobile US shares.
Why Deutsche Telekom benefits
At this point, Deutsche Telekom now has an excellent position. Through the veto rights and the right of first refusal, the company has SoftBank more or less in its hands. Accordingly, SoftBank had to accept a deal that was rather disadvantageous for the company.
- SoftBank pays USD 300 million to T-Mobile US.
- Deutsche Telekom receives new board seats and call-options that will enable it to secure a majority stake in T-Mobile US over the next four years.
- Almost half of the options have a fixed purchase price of approximately USD 103 per share.
Deutsche Telekom now has four years to exercise the call options, which is a very comfortable situation because it allows the company to plan for the long term. With a current debt to asset ratio of over 73 percent, this flexibility is also very welcome as it allows Deutsche Telekom to acquire even more shares in the highly profitable T-Mobile US.
T-Mobile US is currently also fairly valued from a fundamental perspective. If the adjusted profit is taken into account, the company is even slightly undervalued. Even though the fair value will fall this year and next year due to COVID-19, the current share price should still represent a favorable price for Deutsche Telekom in the long term.
What is the Deutsche Telekom stock good for?
I currently also think Deutsche Telekom is an interesting share. You should not expect strong profit growth in the medium term. Investments in 5G will continue to swallow up a lot of capital. However, the company still generates an enormous cash flow, which will probably continue to grow in the future. Besides, the company has over USD 6 billion in cash and cash equivalents, almost twice as much as the annual dividend payments.
Operationally, the company is also doing well, as the latest quarterly results have shown:
- Revenue up 2.3 percent in the first quarter to 19.9 billion euros.
- Adjusted EBITDA AL up 10.2 percent to 6.5 billion euros.
- Adjusted net profit was up 8.5 percent year-on-year to 1.3 billion euros.
The company has also confirmed that it expects little impact from COVID-19. In this respect, I do not anticipate any strong adverse effects in the medium term that could place an additional burden on the company. Against this background and the good performance, Deutsche Telekom is valued rather cheaply in fundamental terms.
(Source: Fair value calculation Deutsche Telekom)
Deutsche Telekom has turned a good deal into an excellent deal. It has renegotiated once with SoftBank and has now also taken the opportunity to secure further shares in T-Mobile US at a reasonable price. The company currently has four years to explore its finances and exercise its options, which will increase its share in the fast-growing T-Mobile US. The US subsidiary already produces a large part of the profits of the German parent company. With an annual dividend yield of over 4 percent and a price below the historical fair value, Deutsche Telekom remains an attractive investment for investors seeking a bond substitute.
Deutsche Telekom is part of my diversified retirement portfolio. If you enjoyed this article and wish to receive other long-term investment proposals or updates on my latest portfolio research, click “Follow” next to my name at the top of this article, and check “Get email alerts.”
Disclosure: I am/we are long T, DTEGF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.