AT&T Post-Merger: Time to Pull the Plug

Includes: T, VZ
by: SA Eli Hoffmann

Excerpt from our One Page Barron's Summary (receive it weekly by email by signing up here):

COVER STORY: Unplugged by Jacqueline Doherty

Highlighted companies: AT&T Inc. (NYSE:T), BellSouth Corp. (BLS), Verizon Communications Inc. (NYSE:VZ), Comcast Corp. (NASDAQ:CMCSA), News Corp. (NASDAQ:NWS), EchoStar Communications Corp. (NASDAQ:DISH), DirecTV Group Inc. (DTV)
Summary: Friday afternoon the FCC approved AT&T's $86 billion acquisition of BellSouth. The combined company will provide retail phone service in 22 states, own the largest U.S. cellular company (Cingular Wireless), and become one of the biggest business telecom providers. But the $225b conglomerate faces significant challenges:

  • Recent deals fail to address the ongoing decline in the retail telephone sector; retail line customers are dropping by 2%-4% each quarter as they opt for wireless or VOIP.
  • Cable competitors are preparing to deliver a triple-play of voice, video and internet service, stealing customers and deflating prices. Competitor Comcast signed up 483,000 telephone subscribers in Q3, compared with 326,000 in Q2 and 211,000 in Q1, bringing its total to 2.1 million. And cable providers say once they're entrenched in the retail market, they will begin going after AT&T's commercial accounts.
  • To counter cable's 'triple-play' AT&T is rolling out its own version of voice/video/data, Project Lightspeed, which combines fiber and copper AT&T 31 12 2006 Chartwires to deliver video to customers' homes. But skeptics worry whether the company can make the technology work over large areas. The system sometimes crashes or freezes, and there are rumors that AT&T is finding its servers can't handle as many homes as expected. The company might need to use more servers. Other solutions, such as buying a satellite company or rolling optical fiber to homes as competitor Verizon was forced to do, are costly but potentially unavoidable. Some analysts speculate that once the BellSouth deal closes, AT&T will acknowledge Project Lightspeed isn't working.
  • The most enthusiastic forecasts see AT&T revenue growth of only 1% in the next two years; anticipated double-digit earnings, if they materialize, will be mainly from post-merger cost cutting.
Bottom line: Shares are up 46.5% this year to a recent 35 amid enthusiasm for the BellSouth deal. They currently trade for 13.6x next year's expected earnings. If AT&T's P/E multiple retreats to 11, the bottom of its normal range, the stock could fall nearly 15%, to $30. If the company misses Wall Street's earnings targets, the downside could be greater. Investors are advised to pull the plug now.
Related: Net Neutrality: The Real Issue Behind the AT&T/BellSouth Showdown, AT&T Promises to Respect 'Net Neutrality' in Revised BellSouth Merger Plea To FCC, AT&T May Buy DirecTV, Says UBS, AT&T Considers Its Next Move, AT&T: Unfulfilled Innovations Since 1993, Can Direct-Broadcast Satellite Build a Third Broadband Pipe?, Citi: Buy AT&T and Sell Verizon, Jim Cramer's Take on T. Conference call transcript: AT&T Q3 2006