Citi: Buy AT&T and Sell Verizon

Michael Rollins, telecom analyst at Citigroup, on Monday cut his rating on Verizon (VZ) to Sell from Hold, while also increasing his rating on AT&T (T) to Buy from Hold. His basic thesis is that AT&T “has greater earnings power than Verizon over the next three years with a cheaper P/E and P/FCF [free cash flow] valuation” when you factor in completion of the pending AT&T acquisition of BellSouth (BLS).

Why Rollins likes AT&T:

• BellSouth merger likely to close soon.
• Expects expanding margins at Cingular, with lower than previously forecast capital spending.
• Cash and non-cash synergies from the merger should fuel earnings growth.
• Fiber-to-the-note video strategy lower cost than Verizon’s fiber-to-the-home approach.
• Could increase dividend, buyback program in 2007.

Why Rollins doesn’t like Verizon:

• Dilution from Verizon’s FiOS (fiber optic services) IP television initiative “likely to be greater than current guidance.”
• Wireline operations likely to weigh further on results, with 7.8% line loss this year and 7.2% next year, somewhat less than expected losses for AT&T of 6% this year and 6.2% next year.
• Expect asset restructuring to be dliutive to earnings.
• Free cash flow likely to fall below current dividend payout in 2007.
• Consensus earnings estimates too high.

Comments

[Kris Tuttle:]

Maybe true in the short term. I haven't taken a deep look at the stocks. However, it seems to me that the Verizon is doing vis a vis their fiber build out is set the foundation for a long future if increased ARPU and lower operating expenses for their digital subscribers. They should be able to take a customer from 2MB to 140MB/sec over time and charge accordingly for basically zero incremental investment.

Also it appears that customers are making a video decision first and then looking to add voice and other services to the IP. If true consumer behavior it will make having a strong video platform a good advantage in competing for the next round of customers.

2006 Oct 10 05:12 PM

[Bharper:]

I would disagree with the analysts conclusions. The market is overly discounting Verizon due to their fiber rollout. FCF is certainly going to be lower, but that is because they are pumping capex dollars into growth. Same goes for earnings as they depreciate their new investment at accelerated rates.

Verizon is significantly cheaper...they are selling for 1.5 times sales versus 3 times for AT&T. And AT&T is swapping stock for Bellsouth shares trading at 4 times sales. Historically the co's margins have been comparable...at present AT&T is posting margins near their historical average, whereas Verizons are near an all time low.

If analysts don't like a stock, it has nowhere to go but up, and vice versa.

2006 Oct 20 05:35 PM