I am bullish on AT&T Inc. (T) as it offers a healthy dividend yield and stable cash flows from operations. Given the recent turn of events, T has been provided with ample opportunities to expand its wireless business in international markets. With the company's new initiatives, I am expecting favorable growth in revenue and EPS. Furthermore, the company is trading at the bottom end of its 52-week range, and based on my price target it has the potential for an 11.5% price appreciation.
The much awaited deal between Verizon Communications Inc (VZ) and Vodafone (VOD) has been finalized. This deal has provided T with an opportunity to expand its operations in Europe, where it has been specifically looking to utilize wireless growth opportunities. The deal with VOD will enable the company to get access to European markets, as VOD operates in many markets, including the U.K., Germany, Italy, Spain, and Netherlands, along with India and Africa as well. However, I believe that with the significant cash infusion, after selling its crown jewel investment, VOD is under serious pressure to explore other growth opportunities. As hinted earlier, the basic motivation behind T's interest in Europe is that the company wants to expand its wireless operations, especially with regards to deploying its 4G LTE network, which is not extensively available in Europe. However, VOD has some other plans for expansion, as it is looking to acquire wireline businesses such as Kabel Deutschland in Germany, and Fastweb in Italy. Robin Bienenstock, an analyst at Sanford C. Bernstein, has attached a price tag of around £80 billion or $124 billion on a possible deal between the two companies.
Another attractive opportunity for international expansion has also opened up, as VZ calls off its invasion in the North. The Canadian government has refused to amend any regulations, which means that international incumbents still have an edge, and with the bright wireless expansion prospects in Canada, I see no reason why T cannot avail this opportunity. I think this is the right time for deep-pocketed T to look for international exposure; three reasons support my thesis. Firstly, revenue growth is slowing down in the U.S. mainly because most people now have smartphones and data plans. Secondly, the competition is heating up as smaller players such as Sprint and T-Mobile (TMUS) are challenging the big players more aggressively. Lastly, VZ is busy with the biggest deal of the decade to double its position in the U.S.
Possible acquisition of Leap Wireless
T is looking to buy Leap Wireless International Inc. (LEAP). This will enable the company to get its hands on the 700MHz spectrum and acquire around 5 million new customers. With the ever increasing demand for bandwidth, this new 700MHz spectrum will be an important addition to the company's arsenal, as the company is already facing spectrum and capacity constraints in certain markets. Furthermore, the expected increase in the customer base in such a competitive industry is a big deal, which will significantly contribute to revenues. I also believe that regulatory authorities will not disapprove this deal like they may have done in the past when T was planning to acquire TMUS. LEAP is a small company with annual revenues of $3.05 billion, which actually does not impact T's competitive position in the industry. However, the acquisition has two major concerns. Firstly, a major chunk of LEAP's customers have prepaid connections, which means that average revenues will be significantly less than those of postpaid connections. Secondly, T will also have to absorb total debts of $3.64 billion. The deal still hangs in the balance, as the FCC is still reviewing it. However, T has reported that it would like to close the deal within the next six months.
Financial performance of 2Q'13
The company managed to improve its revenues by 1.58% YoY; this growth was reflected in the company's bottom line, as its EPS was up by 7.6% YoY. These results were led by a strong performance in the company's wireless segment, which experienced a growth of 5.7% YoY in operating revenues. However, the wireline segment continued to perform poorly, excluding consumer market revenues, which experienced a rise of 2.4%. Furthermore, operating income margin reduced to 19.1% as compared to 21.6% in the second quarter of 2012. This decline was primarily attributed to higher wireless equipment costs associated with handset upgrades, an increase in supporting expenses to U-verse, and higher advertising expenses.
The company managed to improve in several key aspects, which include its subscriber base, postpaid net additions and postpaid average revenue per unit. Moreover, smartphone sales reached 6.8 million, out of which 88% were postpaid connections. Strong wireline postpaid revenues were primarily attributed to a good performance by U-verse, as its revenues grew by 30.1% YoY and its customer base has expanded to 9.4 million. Furthermore, T enjoys one of the fastest and most reliable 4G LTE networks in the region. Its LTE network has been covering 328 markets, and it is expected to be deployed completely by the end of the summer next year. Finally, the company generated $9.5 billion in cash from its operating activities, which provides the cushion to its healthy dividend yield of 5.2%. I will also be using T's free cash flow strength to determine its share price.
Discounted Cash Flow Evaluation
I have used the free cash flow estimates until 2016 and a 7.52% WACC (using cost of equity of 9.25% and cost of debt of 3.5%). Furthermore, I have used a terminal year growth rate of 0.5%.
Terminal Value of FCF
Estimated Free Cash Flow
Total Value to firm = 15,638+15,080+14,583+224,896=$270,197 million
Total Debt= $52,881 million
Total Value to firm - Total Debt = Total Equity value
$270,197 - $71917= $198,280 million
Share Outstanding = 5,335 million
Target Price = Total Equity Value/Share Outstanding
$37.17 = $198,280/5,335
P/E Multiple Evaluation
Average P/E of T
T - Estimated 2014 EPS
My price target is $37.2 per share. Based on my price target, we can expect a price appreciation of 11.5%. Furthermore, with a dividend yield of 5.30%, the company offers striking total return.
4G LTE Network
Competition is heating up, and the company's wireless segment is challenged by VZ and Sprint Corporation (S). In order to continue its wireless momentum, the company should prioritize the completion of its 4G LTE network, which will enable the company to increase its ARPU and operating margins. Furthermore, T should focus on deploying LTE small cell networks in urban centers to ensure high quality and better security management. This service will be extremely useful for businesses that need more bandwidth for their large data sets.
The company is exposed to the economic cycle and additional spending is primarily dependent on an economic recovery. The competitive pressure is building up, after the investment of SoftBank in Sprint and the acquisition of MetroPCS by TMUS. Regulatory risk continues to be an important factor, as it can change the industry dynamics.
The company has always been popular among retirement and income accounts due to its strong dividend yield and long history of dividend payments. I also believe that wireless technology still has the potential to drive growth, and it will continue to play an essential part in the company's growth. The company has deep pockets, so infrastructure and network build-up is not a worrying sign. Therefore, I believe the company provides an excellent opportunity for investors to maximize their returns through dividends and multiple expansions.