Is AT&T Ever Going to Escape Its Rocky Acquisition Past?

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Recently I received a letter from a subscriber. A retired physician asked about volatility and equated the stock’s price to the blood sugar of a patient. It was an interesting analogy.

“Day to day variations in blood sugar can be observed, as can longer-term progressions of blood sugar that fall within the expected range of responses to treatments. An unexpected spike or precipitous fall in blood sugar requires prompt evaluation and treatment, as might an abrupt change in stock price.”

The author asked about AT&T (T) and Verizon (VZ). And while I’m not able to provide personalized investment advice, I can speak to our entire audience about both companies and what to expect moving forward.

Both companies reported earnings this week. And both are heading in very different directions in terms of their strategies.

Let’s start today with AT&T, which faces a lot of scrutiny in the wake of this quarter’s earnings report.

AT&T — Fool Me Three Times

In May 2021, AT&T issued an announcement that shook up the entertainment world. The company announced it would merge its WarnerMedia division with Discovery Communications into one standalone entity.

The deal was big. It was bold. And it sunk the stock.

AT&T entered its own bear market, with the share price falling from $32.34 to about $26 today.

The company has been burdened, quite frankly, by a lack of a vision and questionable acquisition strategies over the last few years.

In July 2015, the company famously purchased satellite television giant DirecTV for $49 billion ($67 billion if you include the debt), despite stark evidence that consumers were moving over to streaming when in-home network speeds were accelerating and costs were coming down.

While legacy cable companies were experiencing a decline in subscribers, DirecTV’s losses were dramatic. From the first quarter of 2017, AT&T lost more than 9.5 million customers from its Premium TV services division. It went from about 25 million subscribers to 15.4 million at the end of the second quarter of 2021.

And the company violated a few cardinal sins in terms of running a business. It attempted to raise prices — not reduce them — and eliminate promotional deals to drive up the revenue amount per customer.

In August, the company spun off DirecTV and its other premium networks in a deal with private equity firm TPG. The deal valued the new entity at just $16.25 billion, nearly 70% less than what AT&T paid in 2015.

Hope and Optimism

In 2019, many investors had grown tired of the quagmire at AT&T. But there was temporary hope when activist hedge fund Elliott Management purchased a $3.2 billion stake in the company. At the time of the announcement, shares traded north of $36.

The fund made strong-conviction statements that AT&T was worth $60 per share as a “sum of the parts.”

“The purpose of today’s letter is to share our thoughts on how AT&T can improve its business and realize a historic increase in value for its shareholders,” Elliott Management wrote in a memo. “Elliott believes that through readily achievable initiatives — increased strategic focus, improved operational efficiency, a formal capital allocation framework, and enhanced leadership and oversight — AT&T can achieve $60+ per share of value by the end of 2021.”

But the investment was short-lived. Elliott exited its position in November 2020. So the big battle that was expected and the value that was supposed to be unlocked never came.

Anyone following activist hedge funds to develop potential investment ideas simply threw up their hands and wondered, “What was the point?”

Offloading Time Warner

AT&T has a history of poorly timed deals. Besides the woes around DirecTV, its Time Warner deal in 2018 raised eyebrows as well. To participate in the ever-brewing content wars, it purchased the entertainment company for a staggering $85 billion ($108 billion including debt). Three years later it is spinning off the Warner Media division for $43 billion in cash and debt. Shareholders would receive 71% of the new company, which includes a merger with Discovery Communications.

This new entity will compete against Walt Disney and Netflix in an already saturated content market. The deal will close in mid-2022, according to the company.

Finally, AT&T executives appear ready to focus their attention on the very simple idea that it is a cellular phone and internet company. The company is looking to pay down debt and increase its investments into the new 5G spectrum.

So far, these investments have shown success. The company added 928,000 new phone subscribers during the third quarter. That figure blew away expectations of 560,000 new subscribers, according to research company FactSet.

For the most recent quarter, AT&T reported adjusted earnings of $0.87, topping expectations of $0.78 per share. In addition, revenue of $39.9 billion in the third quarter beat expectations of $39.14 billion.

While these figures are positive, there still are some challenges that the company faces in the months and years ahead. First, its total debt hit $179.2 billion on Sept. 30.

Second, although the company now pays an 8% dividend, it appears unclear whether AT&T will fund that figure in the years ahead. As a pure-play telecommunications company, analysts initially expected to see annual cash flow top $20 billion. As a result, its free cash flow payout ratio would be in the 40% to 43% range.

However, analysts at research company KeyBanc Capital Markets took a deeper look into those numbers and now anticipate that the free cash flow figure will be in the $16.6 billion range. As a result, the dividend does not appear to be safe, and a lower payout and/or lower FCF figure will likely impact the share price.

Finally, AT&T is mired by ongoing supply chain problems. To attract new customers, it is pushing an aggressive campaign with the new iPhone 13. Recently, Apple announced that it would produce fewer devices than expected due to the ongoing semiconductor and supply chain crunch. Such limitations in new iPhone shipments could hinder AT&T’s aggressive push in the quarters ahead.

AT&T has been in the Red Zone of TradeSmith Finance since Oct. 12, and shares have experienced sideways momentum since July 14. So, for now, we are avoiding the stock and waiting for some clarity about the company’s shift as a pure-play telecom company.

We will continue to monitor it, but there appear to be too many risks and a lack of price momentum for right now.

We’ll dig into Verizon on Monday.