Last week, I said that AT&T (NYSE:T) had failed to match the competitive threat from Verizon (NYSE:VZ) and smaller players like Softbank's (OTCPK:SFTBY) Sprint (NYSE:S) and the Un-Carrier, and that this would hurt its revenue either through fewer customers or a second round of price cuts. I also postulated that a revenue cut of "as much as" $6 billion was not completely out of the question.
My thesis was strongly criticized. Some simply pointed to AT&T's strong track record on growing dividends, others to AT&T's aggressive innovation posture in entertainment. Fair points. Others said that my math was too rough and approximate to be an accurate reflection of AT&T's potential risk.
Today, I want to update my findings in light of new developments. I also want to address some of the points that have been made.
AT&T's Risk Profile
Analysts have also disputed that AT&T will be hurt, pointing to a few different factors to support this conclusion: relative network qualities, increasing price competitiveness at higher line penetrations and, most importantly, a relatively low P/E factor that should insulate AT&T stock even if the subscriber count takes a hit.
Investors should find none of these reassuring.
I covered most of this in my last article, so I will only briefly recap here. Let's take these in reverse order. First, AT&T's P/E ratio. It is indeed lower than T-Mobile's (NASDAQ:TMUS) but that is not surprising considering that T-Mobile is the undisputed growth king of the sector. Investors are pricing in a healthy premium to their current earnings as they project the growth to continue.
The proper comparison is between AT&T and Verizon. Both companies occupy similar competitive positions at the top of a - crumbling - duopoly. Both have reported similar subscriber figures the last few quarters, a fraction of T-Mobile's. And yet Verizon's P/E is actually below AT&T's. Currently 15.5, compared to almost 20. So AT&T may not have the cushion some think.
Meanwhile, the network quality is just the inverse. Verizon's is higher than AT&T's, despite charging less per month.
The last point made was increasing competitiveness at higher line numbers. This was actually never true. AT&T was charging $40 per line when this claim was made, while every other competitor was charging $20. So competitiveness actually got worse at higher line numbers. Do the new developments change that?
Even AT&T Admits They Fell Short
Today, AT&T announced that beginning Thursday it will overhaul its Unlimited plans for the second time in two weeks as it continues to seek to narrow the gap with Verizon's customer proposition enough to stay relevant to consumers in the wireless price war. As expected, the initial decision to leave its Unlimited plans unaltered and simply open them to everyone without a TV subscription, proved entirely insufficient.
Rather than suffer the subscriber loss, AT&T has decided to take another step toward matching the offers from its higher-quality network competitor as well as perpetually scrappy underdogs T-Mobile and Sprint. While it has taken another positive step, it still falls short.
The plans are a definite improvement. AT&T finally matched the offers on hotspot data and also agreed to cut the prices of its plans. But its hotspot will throttle to 2G instead of 3G when the high-speed capacity is exhausted. AT&T also made pricing changes, but these are helpful without really being adequate, despite AT&T coming down to $20 per month on additional lines. There are lots of possible permutations of the news plans, depending on line number and device type, but AT&T remains the most expensive provider at every subscriber count and price point. So AT&T has shrunk the gap at higher line numbers, but not eliminated it.
One Hidden Hike Among The Cuts
In some ways, it has even gotten worse. In my article last week I noted that under the original Unlimited plan AT&T was only behind Verizon at the one and three lines counts, as well as lines five and up. It actually matched - but did not beat - Verizon prices for two- or four-line plans. Under this new plan, that actually has been eliminated: Verizon now beats AT&T clean across the board. No ties, either.
This is because AT&T cut the price of the first line by $10 - remaining behind Verizon, which it had trailed by $20 - but actually hiked the price of its second line by $15. The net effect is to take its two-line plan price up by $5, destroying the tie there. And with AT&T and Verizon price-matched on every line after the second, AT&T is basically $5 ahead of Verizon on every plan price, two lines and up.
I continue to have the same question I had before. Why is AT&T's slightly less good network worth slightly more per month, with the two plans offering the same services and perks? But certainly the gap is much smaller now than it was. That will certainly help, but maybe not enough. I believe AT&T Wireless remains at risk even after these changes.
It remains only to try to quantify that risk. I was criticized last time for ball parking my estimates, being to vague and broad. In my defense this was because the whole point of the article was that AT&T's plans were going to change soon, which would change the math as well. It seemed pointless to deep dive on plans that weren't going to stick around, hence my quick and rough estimate.
I still think AT&T's plans aren't enough, but I expect these will stick around longer than the last ones will. So let's do the deep dive now and I will try to be much more specific.
I have re-read AT&T's most recent subscriber metrics from their 4Q2016 earnings. AT&T has just under 135 million wireless subscribers. Of these, 81.5 million are business and 53.5 million are consumer, rounding. In my last article, I excluded business accounts completely and included all consumer accounts in the calculations.
This was pointed out by some to unfairly penalize AT&T by ignoring that some consumer accounts are connected devices, reseller, or in other ways unaffected. Fair enough. But the exclusion of business accounts also unfairly inflated AT&T's numbers. As I said, this was a rough exercise last time.
Let me try something a little more precise. To break down the numbers another way, AT&T also reported that of its 134.9 million connections, 77.8 million of them are postpaid connections, with 59.1 million of those being smartphones. Leaving 18.7 million tablets, feature phones and hotspots in the postpaid column. Obviously the feature phones will not benefit from the unlimited data option. But tablets certainly will, as will hotspots. And they also qualify as new "lines" for the new $20 unlimited price.
As I said, there are almost 78 million postpaid accounts. It is true that business accounts do not have the same use for Unlimited data that consumer accounts do. But the damage to AT&T is actually worse if you exclude them than if you include them. I will show why.
The Law Of Averages
I also was criticized for failing to understand that a lot of people don't need unlimited data, and therefore won't want to pay for it. And also that a lot of people are on older, cheaper plans they won't want to leave. The business argument is essentially the same point made in another context.
These are perfectly valid points, but they actually hurt the bullish argument more than they help it. The reason is that we already know the average postpaid monthly fee paid: $58.84. If someone is paying less than that, then someone else is paying more. And by the law of averages, larger deviations from the mean actually hurt revenues, they don't help them.
If three lines are paying $58.84 each and they go down to $45 each - the average price on the now "old" unlimited four-line plan - AT&T loses less revenue than if one line is paying $40 and the other two are paying $67.50 each. The reason is that the $67.50 lines will still go down to $45 and the $40 will stay at $40. So AT&T would have $130 from the three lines every month, instead of the $135 it would have gotten from all three lines paying enough to make the full $45 worthwhile.
This is true of any post-cut revenue calculation. The way to maximize post-cut revenue is to have everyone at average, so everyone will find it worthwhile to pay the highest possible post-cut price. My calculations last article, using a flat average postpaid revenue for all lines, are actually the most optimistic ones possible. Lower-priced lines only make it worse.
Losses On Phone Customers
So best-case scenario, all 59 million postpaid phone connections are paying enough that it may be worth their while to switch. Throw in the tablets and hotspots on top of that. AT&T also told us that the average size of a Mobile Share account is three connections, which comes to $175 in monthly fees at average. Three unlimited lines on AT&T were $180 before, which could have almost limited the damage except that four lines came at the same price, hence my use of the four-line payments in my original calculations. Besides which Verizon offered four lines for the same price, and three lines for $160.
But now, AT&T has made two changes. First, it now sells a three-line plan for $165. Second, it now sells a downgraded Unlimited Choice plan for $135, for those who don't need full LTE speeds on their phone. AT&T is thus looking at a loss of anywhere from $10-$30 per three postpaid connections. But the $10 loss, on a $165 plan, is still less than Verizon, which saves $15 and offers a better network. So the real loss is $15-$30 per three lines per month, or $5-$10 per month, per line. Again, this is the most optimistic interpretation. The charges will not be perfectly average across the company.
I will call it 60 million connections at risk, throw in only a few tablets and hotspots. The loss will be $60-$120 per year assuming all prices are matched but no one actually quits the service. That is $3.6 billion to $7.2 billion in foregone revenues on phone customers.
Wrapping Up The Numbers
There is one final element, however. To make its unlimited plans more attractive to DirecTV/U-Verse customers, AT&T will give out a $25 monthly credit to any TV service, including DTV Now, to non-Choice customers, the Unlimited Plus group as its called. That is an additional $300 per year for those customers.
AT&T reports that it was up to 7.9 million unlimited data customers as of December 31st who back then had to have TV service. Assuming the same three lines per account, that comes to 2.6 million TV accounts now receiving $25 off, rounding down. That comes to an additional $780 million per year.
If we take the midpoint on the phone estimates above, AT&T has about $6.18 billion of current revenue at risk after these more detailed calculations. My "too rough" math actually wasn't too far off.
I don't think it will happen overnight, but I do think it will happen. AT&T remains at risk in the wireless price wars in my estimation, and a loss over time of as much as $6 billion annual revenue still seems to me a fair estimate of the potential impact. AT&T's P/E may also reset to Verizon levels as competition intensifies, and so should not be counted on to cushion the stock. While I do not recommend a short position, I also do not consider AT&T a buy at the current price levels.
Disclosure: I am/we are long S.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.