Why AT&T Is a Strong Growth Story

AT&T (T) presents an above-average opportunity for at least the second half of 2009 because of its continued growth prospects with the reduced price iPhone/iPhone 3GS, attractive valuation, and remarkable yield. These characteristics outweigh my fears related to the uncertainty surrounding the Department of Justice probes and risks that AT&T will lose its exclusive contract with Apple (AAPL) for future iPhones to Verizon (VZ) or another competitor. Fundamentally this is a sound company that just happens to be surrounded by a lot of market noise.

The iPhone growth story has been written and reported ad nauseam so I will keep this brief: the iPhone trumps the competition. RIMM is a great company with a strong business (and growing consumer) presence but it lacks the breadth of apps or ease of use to really compete with the iPhone. Palm’s (PALM) Pre is the talk of the town but it will have severe difficulty breaching Apple’s walled garden or being able to reach critical mass with consumers. There is little debate that the iPhone has been anointed as the de-facto popular smart phone right now so investors may as well enjoy the ride similar to MOT (MOT) during the Razor craze (take note of MOT’s chart before, during, and after the Razor era for a warning tale).

In terms of valuation, with a trailing PE of less than 12 and forward PE of less than 11, I believe that AT&T’s growth is being underestimated. Despite sales being relatively flat TTM and the economy still uncertain, I cannot fathom T’s EPS growth falling by half as some analysts predict. While the liquidity ratios are lower than I usually like for stocks I recommend (.5 quick and .6 current), they are in-line with the industry averages: with a market cap well in excess of $100B, this should not even be an issue.

The return on assets and on investment are both greater than the industry averages (4.8 and 7.8 versus 4.1 and 7.3, respectively) indicating management effectiveness yet the company is trading at a twenty-five basis point discount of price-to-book. The only additional thing that I would like to see management do is repurchase some shares, but with the yield, I cannot complain.

The dividend yield in excess of 6.7% is robust and appears safe, although the payout ratio over 75 is entering the danger zone. Given the fact that cash from continuing operations alone is virtually high enough to cover all other cash obligations, you have a certified cash cow; however, I do not envision T raising its dividend much (if at all) in the future. The yield is already significantly higher than historic averages and I anticipate capital expenditures to ramp up as T continued to develop/expand its network to keep pace with the iPhone traffic.

In closing, I do not believe that the DoJ inquiries will have a material impact on AT&T, although I do see the elevated uncertainty slowing its stock price appreciation in the coming months (but, hey, that’s what the meaty yield is for!). These type of exclusive agreements are nothing new and have existed for entertainment software (read: videogames) since the birth of the industry. With the economy in such poor shape and talk of a second stimulus, I hardly think investigating the telecom industry and luxury phone contracts will become a priority. AT&T should be able to keep its exclusivity with Apple because AT&T needs Apple and is far more willing to subsidize its phones than other carriers would be. Now that AT&T has eaten from Apple’s growth tree, I do not see it giving that growth up very easily. At the very worst, AT&T has lots of new subscribers locked-in with two-year contracts that should lessen the blow of potentially losing the exclusive contact.

Disclosures: I am long T, AAPL, and RIMM. I hold an immaterial position in MOT.

Comments

[skwestorange:]

Have you given thought to subscriber growth (better, lack thereof) in their wireless since that is the largest contributor to their cash flow ans profits. Specifically, think about the fact that US wireless penetration is around 90plus %. Finally with the unemployment situation not likely to get better in the next couple of years according to many leading economists, think about the charge offs and loss of subs.

Jul 09 08:58 AM

[buoy:]

Life without a telephone is difficult.

Jul 09 09:11 AM

[john12345:]

Peter Lynch recommended visiting the company's operations and becoming familiar with it's operations. He was very successful with Dunkin Donuts etc for a long period. I suggest you visit an ATT outlet and try to get service of any kind. For more fun, go to their website or call them. Then call a psychiatrist. This is one of the problems when stock analysis looks at financial info and data and avoids the reality of where the rubber meets the road. ATT will drive me to Pre, Rim or other in spite of the iPhone's great features. By the way, can you help me get the email to work on my iPhone?

Jul 09 10:15 AM

[JamesApple:]

For all intensive purposes, the best iPhone support in the world are the iPhone geniuses at the Apple Stores, far superior to anything I can imagine on this planet. I applaud these Apple Geniuses for their superlative contributions to mankind in the area of knowledge sharing and tutoring in making what is already super easy iPhone even painlessly smoother experience.

I also abhor the complacencies of the phone carriers of the world, either ATT, Verizon, or Sprint. The runaway successes of the iPhone has produced a generation of arrogance tucking along Apple's coattail for a ride, and this doesn't stop with the carriers only, even incompetent companies like Research in Motion tags on Apple's coattail for the remnants of the smartphone waves Apple has generated benefitting from people who would not subscribe to ATT but chose Verizon's instead.

Rim blackberries are inferior.

Jul 09 10:44 AM

[Brad Castro:]

I want to like both T and VZ, but do you realize just how much debt they're each carrying? For T, it's around $75 billion and for VZ it's just under $70 billion. Granted, that's nowhere near GE territory, but it's still substantial.

I realize they've got no problems with cash flow or with servicing all that debt at the present, but what happens in a rising interest rate environment?

Maybe that's why the current yield on both these stocks is so attractive. Maybe the market is suggesting that these seemingly solid, blue chip companies are at least moderately at risk.

I understand that certain industries are capital intensive, but I can find plenty of other good cash flow companies without all that debt.

Jul 09 10:47 AM

[Anthony B:]

I am wary of any long-term plays in T or VZ because eventually all the texts and minutes will be unlimited (over the internet) and you'll pay a monthly fee for the data plan to your phone (internet device).

It's probably 5 - 10 years out, but it'll happen. It'll be a constant pressure on pricing of their plans, already happening with Sprint, Verizon, and AT&T's price war in their unlimited plans.

Jul 09 11:55 AM

[Paul Zimbardo:]

Thanks for the comment.

I acknowledge that subscriber growth is important and that US wireless penetration has passed ninety percent; however, I see AT&T pursuing less traditional avenues for growth. Specifically, AT&T has been able to take customers away from Verizon and its peers rather than relying on overall subscriber growth. According to a study by ChangeWave in May, “Thirty-three percent of subscribers looking to churn say they'll jump to AT&T--the highest percentage since ChangeWave started tracking these results”. Is this a more costly strategy? Yes, but this is where the industry is heading as it matures. Also, with the rise of smartphones and data plans, AT&T can focus on up-selling expensive data plans to customers which are highly profitable (for proof, take a look at how much it is rumored that AT&T would like to charge for tethering on the iPhone). Another avenue for growth which I did not touch upon in this article is the expansion of the traditional cell phone business model to the rapidly expanding netbook product.

In regards to the economic/unemployment comment, cell phones and internet access have become such a necessity that I am not worried about this. According to a survey by BIGresearch in February, “81 percent of those surveyed were most unwilling to part with their Internet service; 64 percent said they couldn’t do without their cell phones”. It is true that people may delay purchasing the next new gadget but they will not cancel their cell phone service outright (landlines are another issue altogether and look to be going the way of the dinosaurs).

Sources:
www.fiercemobileconten...

blogs.consumerreports....

---


On Jul 09 08:58 AM skwestorange wrote:

> Have you given thought to subscriber growth (better, lack thereof)
> in their wireless since that is the largest contributor to their
> cash flow ans profits. Specifically, think about the fact that US
> wireless penetration is around 90plus %. Finally with the unemployment
> situation not likely to get better in the next couple of years according
> to many leading economists, think about the charge offs and loss
> of subs.

Jul 09 12:02 PM

[Paul Zimbardo:]

Thanks for all of the comments. Please bear with me while I get the hang of replying en mass.

@buoy

Alas, life without a smartphone is even harder.

---

On Jul 09 09:11 AM buoy wrote:

> Life without a telephone is difficult.


@ john12345

I am a big fan of Peter Lynch and his investment strategy but I believe that it is only one aspect of the investment decision. In fact, I have done the following in the last month: (1) called AT&T customer service, (2) visited AT&T’s website, (3) visited an AT&T outlet, and (4) purchased a new cell phone from AT&T. Was the experience great? No. Did I have to call multiple times and deal with unknowledgeable sales people? Yes. Was the experience much worse than what I have heard from my associates with Verizon or T-Mobile? No. Currently none of the big telecoms are trying to compete with their customer service so I did not view this as having a material impact on my financial analysis. This is not the case in other industries as customer service and an operational experience is a tremendous factor, such as in the retail industry.

It is worth noting that AT&T does have a leg-up with the service provided by Apple and its Genius Bar. I have an iPod Touch and I personally had no problem setting up my email service. Check out this account from the most recent eWeek regarding Mr. Sturdevant’s experience with the Genius Bar.

www.eweek.com/c/a/Ente.../

---

On Jul 09 10:15 AM john12345 wrote:

> Peter Lynch recommended visiting the company's operations and becoming
> familiar with it's operations. He was very successful with Dunkin
> Donuts etc for a long period. I suggest you visit an ATT outlet and
> try to get service of any kind. For more fun, go to their website
> or call them. Then call a psychiatrist. This is one of the problems
> when stock analysis looks at financial info and data and avoids the
> reality of where the rubber meets the road. ATT will drive me to
> Pre, Rim or other in spite of the iPhone's great features. By the
> way, can you help me get the email to work on my iPhone?


@JamesApple

I have not personally used the Genius Bar but I have heard good things about their service (although I have also heard it is overpriced). I suspect that you are not surprised by Mr. Sturdevant’s experience with the Genius Bar that I posted above in response to john12345.

I own both a Blackberry and an iPod Touch and it is hard to say flat-out that all Blackeberries are inferior. Both have their uses but I will agree that Apple clearly has the upper hand and momentum right now. I would be foolish to stand in front of the freight train that is Apple.

---

On Jul 09 10:44 AM JamesApple wrote:

> For all intensive purposes, the best iPhone support in the world
> are the iPhone geniuses at the Apple Stores, far superior to anything
> I can imagine on this planet. I applaud these Apple Geniuses for
> their superlative contributions to mankind in the area of knowledge
> sharing and tutoring in making what is already super easy iPhone
> even painlessly smoother experience.
>
> I also abhor the complacencies of the phone carriers of the world,
> either ATT, Verizon, or Sprint. The runaway successes of the iPhone
> has produced a generation of arrogance tucking along Apple's coattail
> for a ride, and this doesn't stop with the carriers only, even incompetent
> companies like Research in Motion tags on Apple's coattail for the
> remnants of the smartphone waves Apple has generated benefitting
> from people who would not subscribe to ATT but chose Verizon's instead.
>
>
> Rim blackberries are inferior.

Jul 09 12:11 PM

[JamesApple:]

@paul.

Thanks for your feedback.

My view of blackberry inferiority is based on an architectural, systemic, and applicational point of view. The blackberry architecture is outdated, closed (it is really fine to to be proprietary as long as it is not closed. It is like a building with no doors and windows), severely limiting, badly structured. I kmow because I worked at Rim before, any changes made to blackberries are done with a prayer. blackberries are also inferior systemically, the blackberry system is slapped together with little cohesion and expandability or maintenability. That's why every blackberry is separate from each other, unlike the upward compatibility of the Apple products which form an ecosystem with each other. This Apple systemicity is the holy grail for the entire industry, even IBM and Microsoft never achieved it, let alone the chaotic Rim. The Apple platform is the emerging computing standard that has taken Apple 3 decades to deliver, just like the fantastic SAP AG software platform. Apple is the only stable, mature, robust forward and backward looking platform from which applications and services cam safely build on without worrying about anything, period.

I guess that makes the Rim blackberries inferior.

Jul 09 12:52 PM

[JamesApple:]

Note: do all that I said matter to the long term stock prices? You bet your asses that they do.

Jul 09 01:10 PM

[Stephen Ros...:]

True they have enough cash flow to cover. But look at their balance sheet: $134 billion in intangible assets. They have -$37 billion tangible equity. The company has $74 billion debt. Current assets $23 billion, liabilities $37 billion. The company never builds real equity with its cash flow. Once the music stops, ATT is in great danger. I believe that VZ and T in the next three years may be the next GM and Chrysler.

Jul 09 01:43 PM

[Paul Zimbardo:]

@Brad Castro & Stephen Rosenman

You both raised excellent points regarding AT&T’s debt level. As you noted, telecom is an extremely capital intensive industry so the risks related to high levels of debt are always present; however, the commitments are manageable. Specifically, the weighted-average interest rates for the next five years are as follows:

2009: 4.3%
2010: 5.2%
2011: 7.1%
2012: 6.6%
2013: 5.6%

I did not conduct an in-depth constructive capitalization analysis of T’s obligations as I did not see any red-flags but it is always important to investigate companies with high levels of debt outstanding.

The intangible asset item is another pertinent observation but your assertion that “ATT is in great danger” is quite the exaggeration. Over thirty years ago, the telecom industry revolved around tangible assets but as of 2006, 79% of telecom assets were intangible. To quote ‘Power of Intangible Assets’ (cited below), “With the introduction of wireless and cellular service, and the widespread use of computers and the internet in the 1990s, knowledgeable investors no longer assessed the value of the sector solely on its tangible assets. The assessment of a company’s capacity for innovation and proprietary technology, its intangible assets, are the most meaningful, relevant, and valuable criteria to assess a telecommunication company’s value.”

Diving into the footnotes once again (my accounting background is coming in handy!) reveals valuable insight into T’s intangibles. AT&T has had no impairment of its intangible assets recently. Unlike traditional goodwill/intangibles that arise from overpaying for acquisitions, much of AT&T’s intangibles are FCC licenses related to radio frequency spectrum: despite being intangible, these are most definitely real assets with value.

Sources:

www.att.com/Common/abo...
adiat.ciateq.mx/wp-fil...

@Anthony B

If we ever reach the point in which the majority of cell phone users are subscribing to data plans, AT&T will be absolutely swimming in cash. Check out the following article from this week’s BusinessWeek which explores even more possible avenues for AT&T’s growth.

www.businessweek.com/m...

@JamesApple

You again make convincing points. The iPhone and Apple’s OS are certainly better than any offering from RIMM but the hardware QWERTY keyboard is going to continue to keep Blackberries relevant in the corporate setting for the foreseeable future. As far as AT&T is concerned, they have great offerings from both Apple and RIMM so the company can offer the best of both worlds.

Thanks all for the comments. I hope that I have been successful in shedding some additional light on AT&T and the industry thus far.

Jul 09 11:31 PM

[CK Finance:]

I think everyone has made valid points. I would only add a few small points:

- AT&T and Verizon are the big winners from the 700 MHz Spectrum. I'm sure this will be a big area of growth for both of them in the future.

- Analysts Estimate AT&T Growth in the next 5 years to be 3.71% (Yahoo Finance). Sure AT&T is losing revenue from landlines, but I think they have the right momentum to achieve better. Like all have pointed out, losing iPhone exclusivity would really hurt though. I would watch out for one of two things next year - lower margins or lower wireless growth. Apple will either squeeze out a better deal for themselves or simply open the iPhone to all carriers. It's obvious who has more to gain from the exclusivity arrangement.

- Dividend payout at 75% of net income seems high, but if you look at AT&T's cash flow statement, you see they are generating a ton of operating cash, particularly from depreciation. It's management's decision whether to reinvest the cash from depreciation back into the business or to return it to shareholders if they have no better use for it. Either way I would say they have quite a lot of room to maneuver with such significant positive cash flow. Key here will be whether it's sustainable; I would say it certainly is right now and will of course monitor as the situation changes.

Jul 10 01:04 AM

[Wisdom vs. ...:]

the reason T and VZ are discounted is because they are spending billions on 3G and 4G/LTE (VZ's cap ex budget is $17B this year); if those customers do not come (ie, that bandwidth does not get sold) then they could go BK (not that i think they will, the risk is simply priced in). remember, quite a few investors lost quite a few billions on the first broadband bubble about 10 years ago. IMO, T is more prudent by focusing on less expensive 3G for now; VZ is more likely to build out their 4G/LTE network before the economy is ready for it. but the nice thing is, you can vote for 3G with T or 4G/LTE with VZ, or short them both if you think they are getting ahead of the broadband market

Jul 11 10:58 AM

[Wisdom vs. ...:]

oops, i meant 'wireless broadband' when i wrote 'broadband'

Jul 11 11:07 AM

[vloscomp:]

AT&T growth in the coming years will be from their U-Verse.

Jul 11 12:36 PM

[Rainmaker986:]

Every stock in the universe has its "Boo Birds". If you listened to all of them you would never buy anything. I own T and the dividend checks cash very well. Perform your DD and ignore all the bitchin' & moaning & urineating & whining.

Jul 12 05:57 PM

[Mike Whalley:]

AT&T seems to be in good shape and a good bet. In fact, a 15% fall in AT&T's profits also does not worry me because i know that in the long run the company will perform. But what bothers me are things that I am reading about AT&T looking at the Indian telecom company Reliance Communications for a tie up. It earlier had tied up with another indian telecom company and made a profitable exit but Reliance Communications worries me. Look at the following numbers for Reliance Communications:
For the last Seven Quarters starting 30th June, 2007 and ending 31st December, 2008, the numbers for RCom and its peers tell the following tale:

Reliance Communications
% change in subscribers over seven quarters 96%
% change in revenues over seven quarters 5%

TTSL
% change in subscribers over seven quarters 81%
% change in revenues over seven quarters 23%

Bharti Airtel
% change in subscribers over seven quarters 104%
% change in revenues over seven quarters 63%

Vodafone Essar
% change in subscribers over seven quarters 102%
% change in revenues over seven quarters 56%

Idea Cellular
% change in subscribers over seven quarters 127%
% change in revenues over seven quarters 68%

Why would AT&T want to tie up with a company that has unanswered questions about its revenue discrepancy (about $ 1400 million) and is undergoing an audit investigation by the authorities??? There are other players in the Indian telecom industry that have a far better performance than Reliance Communications and have solid numbers in place...then why is AT&T focusing on Reliance Communications and why have they not yet clarified anything in this regards. The investors deserve an answer...

Jul 24 07:22 AM