AT&T: The Leg-Pulling Oligopoly Facade And Why I'm Buying

Summary

• Management's decision to cut dividends alienates a broad segment of the company's shareholder base, suppressing shares.
• The WarnerMedia spin-off offers an attractive one-time dividend, augmenting the 4.6% forward annual distribution yield.
• The industry is characterized by intense competition and high capital costs. Rapid technology changes exacerbate these dynamics, counterbalancing the utility-like demand for communications.
• Investors shouldn't expect extraordinary returns from consumer trends, including 5G. Upstream supply chain businesses are more favorably positioned to profit from the 5G rollout.

Ronald Martinez/Getty Images News

Investment Thesis

As the Fed grapples with inflation, leading experts, such as the former Federal Reserve of New York president, predict a recession. These projections might be true, but personally, timing the market isn't my virtue. For all I know, the duration, extent, and severity of a potential economic downturn are already priced in today's frail market. For this reason, I continue building up my positions, gradually adding more shares as we go through these turbulent times, and sticking to a long-term investment strategy that matches my goal of building a retirement fund.

I have never been a fan of AT&T (NYSE:T). I started writing this piece a year ago. Still, I never published it because AT&T was so complex that the sheer attempt to graph subscriber numbers was a toil. Repeated organizational restructuring forced management to regroup and redefine various business segments, hindering the ability to study historical subscriber trends. These figures are critical, culminating in everything the company offers, from network quality to marketing campaigns, customer service, and market position, who are otherwise difficult to assess. Below are some notes from the unpublished draft.

AT&T changes the way it counts prepaid subscribers to exclude session-based tablets

Beginning with the first quarter of 2015, we have updated our definition of prepaid subscribers to exclude session-based tablets, which are now included with connected devices. Prepaid subscribers now consist primarily of phone users. On this revised basis, prepaid subscribers decreased 3.6% when compared to the first quarter of 2014. Q1 2015 report

AT&T restructures business segments after the acquisition of DirectTV

Due to recent organizational changes and our July 24, 2015 acquisition of DIRECTV, effective for the quarter ended September 30, 2015, we are revising our operating segments to align with our new management structure and organizational responsibilities Q3 2015 report

AT&T combines business and consumer segments

To most effectively implement our strategies for 2018, we have realigned certain responsibilities and operations within our reportable segments. The most significant of these changes is to report individual wireless accounts with employer discounts in our Consumer Mobility segment, instead of our Business Solutions segment Q1 2018 report

AT&T stops reporting many segments

Due to organizational changes and our June 14, 2018 acquisition of Time Warner, effective for the quarter ended September 30, 2018, we revised our operating segments to align with the new management structure and organizational responsibilities, and have accordingly recast our segment disclosures for all periods presented. As a result of the realignment to combine all domestic wireless products and services into the Mobility business unit, which is now one of our reporting units, $27,568 of goodwill from our former Business Solutions segment and $16,540 from our former Consumer Mobility segment was reallocated to the Mobility business unit. Q3 2018 report

For this reason, AT&T's pitch of unlocking value by simplifying operations resonates well with me. I finally added AT&T shares to my portfolio, partly because of the benefits of the planned divestments and, more importantly, the expected dividend from the Warner Spin-off, appearing as stocks in the new venture Warner-Discovery, which I plan to sell, to reduce exposure to the difficult to follow video streaming market. The analysis below sheds light on the risks/rewards of AT&T Remain Co.

The Leg-pulling Oligopoly Facade

Telecom service is essentially a commodity. At a certain level of speed, consumers are indifferent to data providers. How many people you know are psyched about 5G? Consumers want consistent, standard, workday service, which I term "quality network," at a reasonable price. These two channels are the primary ways a carrier can differentiate itself from competitors. The lack of avenues for differentiation forces telecom companies to focus their marketing efforts on price and consistency of standard service. Today, for wireless data, this standard is 4G. This is an important concept to remember to keep investors grounded against much-touted "growth" plans and "favorable industry trends" trumpeted by pundits. Given the commodity-like characteristics of communication services, the industry is marked by intense price wars and heavy capital expenditure, an unattractive combination for those looking for above-average returns. Thinking about my new investment, after the spin-off, I will be holding a business characterized by low ROA, which I am okay with, given the current price, but still mindful not to mistake appearances of oligopoly with pricing power.

5G

The 5G rollout is now more Public Relations than sales and marketing at this stage. The service is available at no extra cost on most wireless plans. AT&T, Verizon (VZ), and T-Mobile (TMUS) glorify the tech because of fear of being perceived as having an inferior network. There are no applications or software for 5G that can meaningfully drive demand. Historically apps and software followed hardware installations of wireless technologies (2G, 3G, LTE, and 4G), and in the few times this order switched, contention followed. Think, for example, when Apple rolled facetime. At that time, the AT&T network capacity couldn't handle such an app, pushing management to block it. The benefits of 5G for AT&T are strategic, allowing it to lower data prices to match competitors installing the same tech in anticipation of the day it becomes the new wireless data standard. In previous articles, I pointed out that upstream tech companies in the 5G supply chain are better positioned to profit from the 5G rollout than wireless carriers.

The problem is that 5G installation is pretty expensive and requires new hardware on tens of thousands of sites. The monetary rewards are not as big as many think. The entire debate around net neutrality stems from carriers' desire (led by AT&T) to charge content providers, i.e., Netflix (NFLX), for accessing its "pipes" because the industry leaders feel they are not being rewarded monetarily for their investment, a frustration shared by shareholders.

5G threatens to cannibalize AT&T's fiber-optic business and broadband. I have a 4G phone, which I use as a hotspot for my laptop and sometimes the kids' iPads, Xbox and SmartTV. I have never tested the network's maximum capacity. Still, I did connect four devices at once, with at least two screens streaming videos without interruptions. When I get a 5G mobile, I will test my 5G coverage, and if it is good, I will most likely unsubscribe from broadband and use it as a hotspot, which is a faster and cheaper alternative.

Currently, 5G is more about the market image, with T-Mobile leading the race. But financially, I don't see the tech creating a jump in carriers' revenue.

TMUS Investor Factsheet

Expected Returns

Before the restructuring, AT&T was a dividend aristocrat, growing dividends for more than three decades. Last month's dividend decrease was the first for a long time, alienating many of its fixed-income-hungry shareholder base, suppressing shares. However, when AT&T grew dividends, it demonstrated the viability of its core operations as a lucrative, cash-flow, and relatively stable business. Currently, the forward dividend stands at 0.28$ per quarter, translating to a 4.6% annual yield, in line with peers.

I am happy with these figures, but what prompted me to make the purchase is the Warner dividend. On April 5, will receive 0.24 shares for every AT&T share I own. Last week, AT&T released more details on the planned spin-off. From this new data, and based on AT&T's number of shares, spin-off conversion rate, and the 71% control of current AT&T shareholders of the new venture, I estimate that the total number of shares of the new entity is 7.2 billion/0.71 = 2,448,991,795 shares

The average Price/Sales ratio of five leading video streaming companies is 3.2x. However, this includes outliers such as Netflix and Roku (ROKU), two popular video streaming tickers with above-average multiples. In my opinion, Disney (DIS), Comcast (CMCSA), and Discovery (DISCA) are closer comparables.

Using the average Price/Sales multiples of these three yields a 2.1x ratio. Using 2021 Warner and Discovery Sales ($12 billion + $35 billion = 47 billion), the estimated price per share of Warner Discovery is $38. Thus, the stock dividend I will receive is around $9 for every stake in AT&T, translating to a 37% yield in one day! Nonetheless, one should heed that these are rough estimates, and how the market values the new Warner Discovery is yet to be seen. Also, shares in AT&T remain co might depreciate at the April 5 record date.

Company	Price/Sales
Netflix (NFLX)	5.34x
Roku (ROKU)	4.10x
Disney (DIS)	3.41x
Discovery (DISCA)	1.2
Comcast (CMCSA)	1.88x
Average	3.2x

Click to enlarge

Data from Seeking Alpha

Final Thoughts

Some investors buy the three major carriers, thinking that competition is a zero-sum game, where a loss of one carrier is the win of another. That's not entirely accurate. The market is more like a Prisoner's Dilemma, where, unless all carriers collaborate on pricing (which is illegal), all wireless providers lose.

The industry is characterized by intense competition and high capital costs. Rapid technology changes only exacerbate these dynamics, counterbalancing the utility-like demand for communications. Nonetheless, AT&T demonstrated the ability to joggle these contradicting elements to deliver on a dividend growth strategy. If it wasn't for the Warner spin-off, AT&T might have maintained dividends.

The spin-off offers a lucrative one-time dividend. Shares are trading at record lows, suppressed by management's decision to divest and cut the dividend, alienating a broad segment of its fixed-income oriented shareholder base. Although historically, I have never been a fan of the telecom industry, this situation is too attractive to ignore. For this reason, I am buying AT&T.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of T either through stock ownership, options, or other derivatives. 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.

Comments

[Always Bullish]

What’s the actual ATT yield after spin-off

[chuckfinn]

@DLSheeler Depends on price. If 18 then yield is 1.11/18 or 6.2%

[Pedr0]

@DLSheeler You can actually buy T without Discovery since yesterday the ticker is something like T-WD or T.WD depending on where you look. T-WD is currently trading for about $18, so the yield is about 6.2%

[bengalesq]

Good and quick read. Thanks.

[Baloney Sandwitch]

Lot of sandbagging in this article. Of course, this is an oligopoly, with 3 main competitors dividing up an enormous market. No one said an oligopoly cannot have intense competition. That is one reason a fourth player will have a very tough time. Also, the market is growing at GDP+. I think we can expect a 4% growth going forward. The best strategy is by all three players - VZ,T,TMUS and then go to sleep.

[Doobie80]

Joel Greenblatt is currently holding shares of T in his Gotham Asset Management portfolio. We are in good company.

[MylesL4]

Buy and hold T. Keep WBD as a free option. Win!

[deadhead213]

I’m thrilled for the merger and $T’s future growth. I see $WBD as a catalyst and leader in streaming and will only flourish with a fantastic management team lead by David Z. I plan on holding all of my $WBD shares which equates to 1100 shares. I’m going to venture out by saying this is a sleeper and WBD will triple with 2-3 years. Only time will tell but, I’m locked and loaded abt the future of both CO’s

[kroyals]

WBD is undervalued.

[TommyIrish]

"I have never been a fan of AT&T (NYSE:T). I started writing this piece a year ago. Still, I never published it because AT&T was so complex that the sheer attempt to graph subscriber numbers was a toil."

Good for you - the pit of misery - only ever getting worse.

"The industry is characterized by intense competition and high capital costs. Rapid technology changes only exacerbate these dynamics, counterbalancing the utility-like demand for communications."

Indeed now relatively less attractive as rates go up 2%.

"I continue building up my positions, gradually adding more shares as we go through these turbulent times, and sticking to a long-term investment strategy that matches my goal of building a retirement fund"

Seems illogical - don't see ANY reason to buy before the split.

[anthemmike]

I had no idea that dividends and spinoffs were the same thing. I guess that means I get monthly and quarterly spinoffs from many different companies.

[PROMISE]

@anthemmike you forgot "/s"

[iubryan1971]

Why does everybody continue to calculate the forward dividend yield on T based off the current price of the combined entity, yet the dividend is being adjusted for the spin-off? Sure you can say you're getting a lower yield on your overall cost basis of the current T shares and you'll be receiving less dividend dollars all else equal....but it's frustrating to keep reading the forward dividend yield on T has a 4 handle for yield when it'll yield 6%+.

[chuckfinn]

@iubryan1971 I had the same thoughts on this article and others. 1.11/ 18 = 6.2%

[Sally Miller]

the "simpler" business without that very expensive management layer holdover from their "multidivisional" days would be better. Why not let the telecommunications C suite run the business and get rid of that layer in which resides Stankey and friends? They're the ones that created all the mess in the first place.

[Jlexus1953]

Long T but would not add . Lots of uncertainty as management needs to demonstrate that they can execute, something they have done very poorly up to this date. The new Warner Co could see the stock drop or be flat upon initialization as some shareholders sell but long term this could be a BIG winner. The will have excellent management, content, scale and be in an industry where PE multiples far exceed the 7x they get tied to T. Large debt comes with the package but management already has a plan toward reduction. Hopefully both companies prosper as T could no longer support their dividend with the debt they incurred

[sourdo]

I agree with the author. Well said common sense article. I like the "simpler" AT&T also.

Long 4500 T
long 600 DISCA, I own both for under $25/share cost.

[omarakthar]

@sourdo good for you, i only have 834 T :(
I bought a few months ago just so i could get WBD. Later i realized I could have just bought disca. Which would have been better btw?

[sourdo]

@omarakthar DISC(A,B,K) is the most volatile, T the least, some of each is good for me. I traded both in February, turned over some fast bucks, and bought them both back for less. I wouldn't sell either right now, but I might buy more of $WBDWV.

The 2-3 year potential for both is good for a likely double on money invested for both. It comes down to your cost really.

Good luck.

[thirdcamper]

I see telecom as more a utility than a commodity. It would take a lot to bring me back to T. Maybe someday.

[01ruxbunny03]

I owned T at 26 and sold at 29 when the cut was announced last year.When the dust settles if T is around 17-19 I will buy back in.I have no real use for spinco,they don't pay a dividend and that is what I am after.

[Skeptic01]

Your article informs well without the usual plethora of hypothetical data. You do mention missteps and complexities, which I believe lead to the major problem --- T's stodgy board members whose most notable out-of-the-box approvals have repeatedly facilitated fiascos.

I cannot expect the latest structure to be more successful for T's shareholders with its current board. A retiree may reconsider buying T shares if its share price drops enough for a more attractive dividend yield. I would be more careful.

Although a price drop within a year or two of the spinoff may seem unlikely to some, what is no longer unlikely is that the current dividend would then be reduced or omitted by either current directors, or an aggressive takeover group that buys out AT&T at its lowered price.

In either case, it may be less risky to consider AT&T a potential growth stock. Its institutional ownership has been slightly over 50%, by the way.

[guy goolie]

The 5G opportunity is a marathon requiring the metaphorical sprint in capital spending. It remains to be seen if the carriers will be major beneficiaries of the new high speed aerial technology but at these valuations it seems like a reasonable bet. The $1.12 dividend when the value of the TWD spin is stripped out is somewhere north of 6 percent.

[josephaoppenheim]

I own T at 24. Since it’s just 1.3% of my portfolio and have little risk no matter what happens, I think I’ll just wait and see what happens. The market is rarely rational. Heck, DISCA has high short interest. Why?

[sourdo]

@josephaoppenheim I have noticed that myself, and I have no idea what this means, how can you have so many shares short?

I'm going to sit back and let this cook, its' going to get volatile this month.

[josephaoppenheim]

@sourdo I don’t know how they calculate that. Does it include shares sold short via options? If not, then even scarier since more shares than exist can be in play, plus all the margin used, and the two day settlement delay.

[D-inv]

@josephaoppenheim Good question about the short interest. Seems to that indicates some traders have been selling shares they have borrowed from others with expectation they will be able to buy replacement shares at a lower price. High short interest just may be indicating short sellers have driven the price below warranted by typical supply/demand. Short covering might be in the wings with price spike. Personally expect P/E differential between VZ and T to narrow after WBD spinoff and WBD price to match or exceed current DISCA.

[Yakspeare]

I had T shares for the deal but I sold them, free shares are nice but for the same money I could get loads more DIscovery shares which swap 1:1 for WBD. About 4 times more. Then if I want T I can buy it post merger at a cheaper price and higher yield.

[omarakthar]

@Yakspeare unless T shoots up post-merger. But yours is still a good bet.

[robert paulson 77]

@Yakspeare my guess is T will become more expensive and WBD will be less expensive in the short term. based solely on my gut feeling. good luck.

[Yakspeare]

@robert paulson 77 the prospectus itself says AT&T expects the price of T to drop as a stock dividend of handing out a part of their business. How much it drops by(and theoretically it could not drop but management expects it to). Indeed in their presentations they are promoting a 6%+ yield which definitely implies a drop.

[$Zilch$]

Thanks to 5G, I no longer have cable internet or cable TV.
I test my 5G internet speed regularly and it's 5 to 6 times faster than previous cable internet. My virtual DVR has unlimited storage and is easier to use than previous cable set top box DVR.
5G has changed everything. Cable, twin wire, and satellite dishes are a thing of the past.

[sourdo]

@$Zilch$ That is nice, but we don't all live next to a cell tower. I use up to almost 600 GB,s of data a month with cable. I'm curious on what your plan allows? Is it truly "unlimited".

[$Zilch$]

@sourdo Yes, unlimited. Never noticed any throttling back or slow down.
Dec. 76.18GB of data, Jan. 100.24GB, Feb. 61.82 GB.