After the USD 85 billion Warner merger was approved, it has become relatively quiet around AT&T (T). The investors' focus was mainly on how well the new entity would work and to what extent AT&T would come down from the debt mountain. But then it became public that the hedge fund Elliott acquired a USD 3.2 billion stake in AT&T. Furthermore, Elliott published a public letter.
Activist investors are always on the lookout for supposedly undervalued companies and try to influence management. Although I don't think it's a bad thing in general, here, the whole thing is a bit bizarre because Elliott's demands contain nothing new, but only familiar. In this article I will briefly introduce the demands of Elliott and then explain why I find the entry quite tiring.
The Elliott letter - A sequence of known facts and keywords
The main content of the letter consists of the following points:
(Source: Key points of the Elliott letter)
To be honest, the letter contains nothing new at all. Any investor who regularly reads Seeking Alpha articles will have been able to summarize the sentiment of AT&T with all the pros and cons of arguments. The fact that AT&T has been underperforming the S&P 500 for years is formally cried out to one as a long term investor in the comments. Equally unsurprising for investors is the value of the portfolio. Elliott reiterates that AT&T ranks first or second in the wireless, TV, wireline and media sectors. With this potential in mind, Elliott comes to the following groundbreaking conclusion:
(Source: Elliotts conclusion)
The first thing I thought was that it is a joke in itself that Elliott demands that management be replaced in large parts, because the current management played a major role in creating all the value for investors. The fact that the market does not yet recognize the potential is not the fault of the management. The second thought was that Elliott wasn't even thinking about the mega advertising market, which might be extremely lucrative for AT&T. How exactly, I'll describe later.
However, after that, Elliott describes how the company can unlock all this hidden value. Here are the steps Elliott recommends to the company:
While in principle I have no real problem with activist investors, in this case I see no real added value from these proposals and Elliott's entry.
The Elliott entry changes nothing at all
In my eyes, AT&T is perfectly positioned. The mobility and media businesses performed quite good in the recent past. Asked about the deals Elliott criticized, especially buying DirecTV and Time Warner, Stephenson said:
"If you had asked me that question five years ago, I’d be hard-pressed to say it makes sense, in the old world. In the new world, it makes all the sense in the world.”
Stephenson says the truth in my eyes. Why should AT&T sell DirectTV? Yes, the struggling satellite TV business seems to be a a brake pad because of declining premium TV subscribers and declining industry. Yes, DirecTV satellite service went from 21 million subscribers at the end of 2016 to 17.9 million in the second quarter of 2019. But the first thing is, if AT&T sold the DirecTV, the company would get far less than what it paid. Furthermore, I think there is still some value in DirectTV.
As already mentioned, Elliott has not even considered the advertising business so far. I would go even further and say that advertising could become AT&T's most valuable business. AT&T initially wanted to grow vertically and is now planning a horizontal explosion. Therefore, AT&T bought already existing users through vertical growth and plans to use this potential to create new sources of income. The acquisition of Warner has allowed the company to grow vertically as well as increasing the number of users and data. With its subsidiaries Xandr and Xandr Invest (the former Appnexus), AT&T provides marketers with advanced advertising solutions using valuable customer insights from AT&T's TV, mobile and broadband services, combined with the extensive ad inventory of WarnerMedia's cable networks and AT&T's pay-TV services. Xandr is making AT&T data available to buyers across all media types through AppNexus's demand-side platform (DSP). Given that, AT&T has a very big advantage here that many companies do not have. This is due to the combination of sell-side and buy-side demands within the advertising market. AT&T is able to address both of them in an unique way with its service portfolio. The resulting potential is promising for investors. This focus on the advertising business is already paying off. Advertising revenues across AT&T are more than USD 7 billion on an annualized basis. In Q1 2019, revenues of Xandr were up 26 percent. The EBITDA margin was 62 percent. Accordingly, AT&T's advertising business is highly profitable.
Given that, DirectTV can be used as another distribution channel for AT&T's growing and highly profitable advertising business. In addition, there is another point that not every investor is aware of. Despite declining subscribers, revenues and EBITDA came in quite good. The operating margin also improved. This may be something Stephenson wanted to point when he said:
"And so, as you think about a video portfolio, DIRECTV, AT&T TV, HBO, which we’re getting more and more conviction that HBO Max is going to be meaningful, you can imagine that those are the places we’re going to put our shoulder and our muscle as we move forward."
Even if the segment shows the least profitability, profitability is given and is even increasing. The segment also offers the company an additional distribution channel for content and advertising. And this would be exactly what Elliott demands: the shift from acquisitions to operations. Hence, I do not see a reason to sell here.
And speaking of content: AT&T has hit the bull's eye with Warner Media. You could see that again at the Emmy Awards. Also the Mega Deal with Producer J.J. Abrams shows that. Abrams' mega deal with Warner came together even as Apple (AAPL) offered the creator far more money. Of course you have to place the figures correctly in the total turnover. But content is everything and I see the upcoming streaming service here as absolutely competitive.
What remains is the debt and AT&T also took the absolutely right steps without Elliott. AT&T is making rapid and ambitious progress with its debt reduction plan. Furthermore, AT&T announced that it plans to sell its operations in Puerto Rico and the U.S. Virgin Islands to Liberty Latin America (LILA) for USD 1.95 billion in cash. The transaction includes network assets, including spectrum; real estate and leases; customers, including 1.1 million wireless subscribers; and contracts. With this transaction, the company already surpassed its monetization goal of USD 6 billion to 8 billion for 2019. Accordingly, AT&T will have no problems in meeting its planned debt-levels.
(Source: 2Q 2019 results)
Additionally, AT&T has even more room to deleverage. AT&T has about 1200-1500 towers in the U.S. network that should be very valuable, particularly in today's market. The management expects to have a lot of demand from buyers. Additionally, AT&T has about 1500 or towers in the Mexico market. Here too, management is already looking at those. On top of that, management says that AT&T has a USD 500 million worth of the real estate that's has a "for sale" sign. The latest update from the AT&T management was that the company is very confident in its 2.5 net debt to EBITDA target for the year end.
If the shares fall again now, after the turbulence, that is not bad, then I simply buy again and am happy to be able to acquire more from this undervalued company at a good price.
Investors are now wondering what to do but I think that this is the wrong approach. Rather, investors should ask themselves why they should do anything at all because nothing has changed at all from a fundamental point of view. Only the price per share has risen. This is of course good for the investors who were underwater and bad for the investors who wanted to get into the business or who wanted to drip into an undervalued company. Late arrivals don't have to despair. In the long term, I still see a lot of potential in the share.
So while I am ignoring the background noises, I am still long AT&T and enjoy the momentum and the juicy dividend for now.
I look forward to discussing AT&T's path to success with you in more depth in the commentary section.
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Disclosure: I am/we are long T. 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.