AT&T Stock: The Facade of Leg-Pulling Oligopoly and Why I’m Buying (NYSE:T)

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Investment thesis

As the Fed grapples with inflation, leading experts, such as the former chairman of the New York Federal Reserve, are predicting a recession. These projections may be true, but personally timing the market is not my virtue. To the best of my knowledge, the duration, extent and severity of a potential economic downturn are already factored into today’s fragile market. For this reason, I continue to build my positions, gradually adding more stocks as we go through these turbulent times and sticking to a long-term investment strategy that aligns with my goal of set up a retirement fund.

I’ve never been a fan of AT&T (NYSE:T). I started writing this piece a year ago. Yet I never published it because AT&T was so complex that even attempting to graph subscriber counts was a chore. Repeated organizational restructuring has forced management to consolidate and redefine various business segments, hampering the ability to study historical subscriber trends. These numbers are critical, culminating in everything the company offers, from network quality to marketing campaigns, customer service and market position, which are otherwise difficult to gauge. Below are some notes from the unpublished project.

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

Starting in Q1 2015, we updated our definition of prepaid subscribers to exclude session tablets, which are now included with connected devices. Prepaid subscribers are now mainly telephone users. On this revised basis, prepaid subscribers decreased by 3.6% compared to the first quarter of 2014. Q1 2015 Report

AT&T restructures its lines of business after the acquisition of DirectTV

Due to recent organizational changes and our acquisition of DIRECTV on July 24, 2015, 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 more effectively execute our strategies for 2018, we have realigned certain responsibilities and operations within our reportable segments. The most significant of these changes is reporting 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 acquisition of Time Warner on June 14, 2018, effective for the quarter ended September 30, 2018, we revised our operating segments to align with the new management structure and new organizational responsibilities, and have accordingly recast our segment information for all periods presented. Following the realignment to consolidate all national wireless products and services into the Mobility business unit, which is now one of our operating units, goodwill of $27,568 from our former segment Business Solutions and $16,540 from our former Consumer Mobility segment was reallocated to the Mobility Business Unit. Q3 2018 Report

For that reason, AT&T’s talk about adding value by simplifying operations sits well with me. I eventually added AT&T stocks 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 Warner-Discovery venture, which I plan to sell, to reduce exposure to the hard-to-follow streaming video market. The analysis below highlights the risks/benefits of AT&T Remain Co.

The leg-pulling oligopoly facade

Telecommunications service is essentially a commodity. At a certain level of speed, consumers are indifferent to data providers. How many people you know are thrilled with 5G? Consumers want consistent, standard, everyday service, what I call a “quality network,” at a reasonable price. These two channels are the main means by which an operator can differentiate itself from its competitors. The lack of opportunities for differentiation forces telecommunications companies to focus their marketing efforts on the price and consistency of standard service. Today, for wireless data, that standard is 4G. This is an important concept to remember to keep investors anchored against the much-vaunted “growth” plans and “favorable industry trends” trumpeted by pundits. Given the commodity characteristics of communication services, the industry is marked by intense price wars and heavy capital expenditure, an unattractive combination for those seeking above-average returns. Thinking about my new investment, after the spin-off, I will own a business characterized by a low ROA, which is fine with me given the current price, but always careful not to confuse the appearances of oligopoly with the power of fixation prices.

5G

5G rollout is now more about PR than sales and marketing at this point. The service is available at no additional cost on most wireless plans. AT&T, Verizon (VZ), and T-Mobile (TMUS) glorify the technology for fear of being perceived as having an inferior network. There is no app or software for 5G that can drive demand significantly. Historically, apps and software have followed hardware installations of wireless technologies (2G, 3G, LTE, and 4G), and in the few times that order has changed, discord has followed. Think, for example, when Apple launched Facetime. At that time, AT&T’s network capacity could not handle such an application, prompting management to to block this. The benefits of 5G for AT&T are strategic, allowing it to lower data prices to match competitors installing the same technology in anticipation of the day it becomes the new wireless data standard. In previous articles, I have pointed out that technology companies upstream of the 5G supply chain are better positioned to profit from the rollout of 5G than wireless carriers.

The problem is that installing 5G is quite expensive and requires new hardware at tens of thousands of sites. Monetary rewards are not as important as many think. The whole net neutrality debate stems from the desire of carriers (led by AT&T) to charge content providers, i.e. Netflix (NFLX), for access to its “channels” because that industry leaders feel they are not being financially rewarded for their investment, a frustration shared by shareholders.

5G threatens to cannibalize AT&T’s fiber and broadband business. I have a 4G phone, which I use as a hotspot for my laptop and sometimes the kids’ iPads, Xboxes and SmartTVs. I have never tested the maximum capacity of the network. Still, I connected four devices at once, with at least two screens streaming video without interruption. 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 market image, with T-Mobile leading the race. But financially, I don’t see the technology creating a jump in carrier revenue.

5G coverage by operator

TMUS Investor Fact Sheet

Returns expected

Before the restructuring, AT&T was a dividend aristocrat, raising dividends for more than three decades. Last month’s dividend cut was the first in a long time, alienating much of its fixed income-hungry shareholder base, stripping stocks. However, when AT&T increased its dividends, it demonstrated the viability of its core business as a lucrative, cash-flowing, and relatively stable business. Currently, the forward dividend stands at $0.28 per quarter, which translates to an annual yield of 4.6%, in line with its peers.

I’m happy with these numbers, but what prompted me to make the purchase was the Warner dividend. On April 5, I will receive 0.24 shares for every AT&T share I own. Last week, AT&T released more details about the planned spin-off. Based on this new data, and based on the number of AT&T shares, the conversion rate of the spin-offs, and the 71% control of current AT&T shareholders in the new company, 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-to-sales ratio of the top five 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 products gives a ratio of 2.1x. Using Warner and Discovery 2021 sales ($12 billion + $35 billion = $47 billion), the estimated price per Warner Discovery share is $38. So the stock dividend I will receive is about $9 for every stake in AT&T, which translates to a 37% return in one day! Still, keep in mind that these are rough estimates and the market value for the new Warner Discovery remains to be seen. Additionally, AT&T shares remain co could depreciate on 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

Data from Seeking Alpha

Final Thoughts

Some investors are buying the three major carriers, thinking competition is a zero-sum game, where one carrier’s loss is another’s win. That is not exactly correct. The market is more like a prisoner’s dilemma, where unless all carriers collaborate on pricing (which is illegal), all wireless service providers lose.

The industry is characterized by intense competition and high investment costs. Rapid technological change is only exacerbating these dynamics, offsetting the demand for utility-type communications. Nevertheless, AT&T has demonstrated its ability to juggle these conflicting elements to implement a dividend growth strategy. If it hadn’t been for the Warner spin-off, AT&T might have maintained its dividends.

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

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