AT&T: Competitive Environment Doesn't Preclude A Good Investment Opportunity

| About: AT&T Inc. (T)


Company has been making right moves to address intense competition through competitive pricing.

T’s subscriber base will be positively affected by strategic initiatives.

Investors should keep track of ARPU and margins in upcoming earnings release.

Competition in the U.S. Telecom Industry has increased in the recent past. The wireless business is undergoing secular changes, whereas the Wireless Industry is becoming more competitive. Price wars in the Telecom Industry have significantly increased in recent quarters in an attempt to strengthen the subscriber base. Competitive pricing initiatives were mainly started by T-Mobile (NYSE:TMUS), which benefited its subscriber base, with strong subscriber additions. Other carriers, like AT&T (NYSE:T) and Sprint (NYSE:S), also followed the footsteps of TMUS and reduced prices for their services. Despite the growing competition in the industry, I believe T is well positioned to address the competitive pressure and maintain its market dominance. T has been taking steps to strengthen and grow its wireless operations, and has been working to expand its LTE network. Also, the company has been targeting to lower costs for its U-verse services. A solid dividend yield of 5.20%, attractive share repurchase program, strong balance sheet and aggressive efforts to expand its LTE coverage make T an impressive long term investment.

T is scheduled to report 2Q14 results next week on 23rd July. I expect another strong quarter, as the company's subscriber base and churn are expected to remain healthy. However, T's ARPU and EBITDA margin are expected to be pressurized due to migrations to the no-device-subsidy Mobile Share Value plans. The company has already preannounced that it will add more than 800,000 net postpaid subscribers and record a low churn rate of less than 0.95%. Verizon (NYSE:VZ) also preannounced that it added more than 1.4 million long term wireless subscribers in 2Q14. T is likely to provide details about upgrades contribution towards gross adds in the upcoming earnings release. Also, T is likely to provide details about the success of its Next program and the rollout of its LTE coverage.

Despite the intense competitive industry environment, T reported the strongest postpaid net adds in five years in 1Q14, mainly due to the Next program and 10GB Mobile share plans. I believe T's postpaid subscriber base will remain strong in the future due to its strategic initiatives. However, I also believe the competitive environment will remain intense, as companies will continue to compete on price bases. In 2Q14, TMUS announced several pricing changes. S came up with an offer of to-pay-early-termination-fee and VZ replied with a 10GB plan similar to T's, which kept the industry environment competitive.

Due to intense competition in the industry, ARPU and margins are likely to remain weak for telecom companies in the near-to-medium term. I expect margins pressures for both T and VZ due to increases in marketing expenditure and new network deployments. As T re-launched the Leap Cricket brand, which it recently acquired, network and marketing costs are expected to remain high for 2Q14. Also, T's administrative expense and cost of service will be higher, as it has started to close exiting Leap network operations.

T has also been aggressively working to expand its LTE coverage. Currently, VZ dominates the LTE network with coverage of 306 million POPs. Whereas T's LTE network now covers approximately 290 million POPs in more than 500 markets, TMUS has confirmed that it met its mid-year target of covering 230 million POPs. The expansion of LTE coverage will put pressure on cash flows of telecom companies in the near term. As T has been undertaking growth investments, the company has been taking measures to improve its cash flows. T has decided to sell its wireline operations in Connecticut to Frontier (NASDAQ:FTR) for $2 billion. The deal is expected to be closed in 2H2014. Also, the company sold its $1.6 billion of receivables and received $800 million of cash upfront, while the remaining balance is to be received over the term of the receivables.

Other than expanding and optimizing its wireless operations, T has also been working to optimize its wireline operations. T has agreed to acquire DirecTV (NASDAQ:DTV) for approximately $67 billion, and the deal is expected to close within one year. If the deal is successful, T will be able to add more than 18 million subscribers of DTV to its subscriber base. Also, as Latin America has underpenetrated pay TV market (40% of households are subscribed to pay TV), T can leverage the DTV network to tap the available growth potential in the region. Also, the deal is expected to be EPS and cash flow accretive. Cost synergies are expected to be more than $1.6 billion annually after three year of the deal closing. Moreover, T expects to reduce content costs for U-verse through the acquisition. Currently, U-verse content costs are approximately 60% of its video revenues, which the company plans to reduce by 20%. U-verse has the highest content programming cost of 60% of its video revenues, as compared to DTV's and Comcast's (NASDAQ:CMCSA) 25.4% and 47.4%, respectively.

Despite the competitive industry environment, T remains a good investment option. The company has been taking the right steps to address the intense competition through competitive pricing and other strategic initiatives. The company's subscriber base will be positively affected through its strategic initiatives. However, I recommend investors to keep track of ARPU and margins in the upcoming earnings release, as competitive initiatives could pressurize them.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.