AT&T ($T) — Initiation (9/9/20)

Not usually one to get excited about a big cap company but this looks like a potentially easy bet… Hopefully I don’t lose any credibility for this one!

Was a ~$40 stock and now a $30 stock…
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The quick pitch:

  • At $30 and 7.1bn shares outstanding = $213bn market cap
  • Trailing FCF is $25bn / 8.5x FCF multiple
  • Market is penalizing ATT for past sins in acquiring DIRECTV, AppNexus (Xandr), and more recently Time Warner
  • Divestitures would improve balance sheet with minimal impact on FCF
  • Narrative likely to change as they chip away at debt levels and make a few divestitures which could push this back to historical dividend yield or ~$40 per share

Back in September 2019, Elliott Management issued a letter to AT&T outlining the dumb moves they’ve made and why shares could be worth >$60 per share utilizing Elliott’s plan…

Remember this slide in response to that letter?

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Forget the Elliott stuff for a moment and this is pretty cheap relative to its own history and in comparison to rival Verizon (VZ).

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Normally, I hate using dividend yield as a reliable valuation indicator but with such a long-running history as a “dividend yielder” — it might be a good benchmark for this particular stock.
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Each time shares sell-off to a higher yield, they almost always come back near that long-term historical average.

With a $2.08 per share annual dividend, a 5% yield would = $42 per share — more than 35% higher than today’s share price.

Let’s start with some high level figures…

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AT&T is catching a lot of flack for reportedly putting DIRECTV on the block at ~$20bn or less after paying $50bn for it in 2015… I can’t blame them for trying to add some cash flow to the business after flat-to-down operating cash flow for 8 years from 2007-2014!

With the addition of Time Warner there are now a handful of segments:

  • Communications — wireless, wireline, and TV for business and consumer
  • WarnerMedia — Turner broadcasting, HBO, and Warner Bros film studio
  • LatAm — international satellite TV subscribers
  • Xandr — advertising technology business AppNexus which was acquired in 2018
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Set aside the LatAm and Xandr segments for the moment as most of the value is in Communications and the recently acquired WarnerMedia businesses.

Let’s focus on Communications…

For starters — total revenue is down from ~$154bn in 2016 (following the DirecTV acquisition) to $142bn in 2019… That’s a big chunk of revenue lost…

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Some pieces of this make sense though…

  • First, voice/wireline (landlines) are down from ~$31bn in 2016 to $26bn in 2019 (both consumer and business). This is a 5-6% annual decline and is likely to continue (maybe at a higher pace). Make no mistake, this business is destined for decline regardless of past or recent acquisitions!
  • Mobility is pretty much flat at $71-72bn per year from 2016-2019 — this is consumer and business wireless
  • Next is broadband which grew from $7.5bn to $8.4bn in revenue from 2016-2019. The one bright spot?
  • Last is video — the DIRECTV impact — which fell from $36bn to $32bn… total subscribers fell from about 20m in 2016 to just shy of 18m today (TTM revenue is down to $30bn)

Digging deeper into Entertainment Group…

Video is ~$32bn of the $45bn in Entertainment Group revenue which is part of the $181bn in total company revenue — we’re talking about DIRECTV likely being < 20% of total sales.

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This piece of the business generates ~$10bn in EBITDA — another < 20% piece of the whole ~$55bn EBITDA pie…

Don’t forget that voice and broadband still make up a good portion of the Entertainment Group as well.

Q2 results have people spooked on this piece of the business..

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DIRECTV problems…

This business and the rumors around a potential sale are catching a lot of attention right now. In fact, I think the major reason AT&T is trading so poorly is directly related to the issues associated with DIRECTV…

Yes, this business is in decline and AT&T likely overpaid for it (at $50bn). At the time of the acquisition, DIRECTV was doing $2-3bn per year in FCF from 2012-2014…

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They’ve lost 6m Premium TV subscribers (formerly known as DIRECTV) since 6/30/18 — about 25% of total subscribers.

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It’s nothing new that this business has been in decline… they’ve been losing close to 1m subs per quarter since ~6/30/19…

While spending $50bn to acquire this business clearly wasn’t the best use of that cash, unloading it for $20bn likely isn’t the worst way to generate some cash either… Assuming they can get that price for it!

Advertising weakness…

Aside from DIRECTV, the company is struggling with advertising revenue as a result of COVID.

While the first is likely a permanent / secular issue, the latter is likely a temporary problem… Nonetheless, it has taken a big bite out of revenue recently.

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Cash Flow

This stock is all about the dividend yield whether you want to admit it or not… So why not focus on the sustainability of cash flow and that juicy dividend?

Last few years of FCF:

2015 — $16.7bn2016 — $17bn2017 — $17.4bn2018 — $23bn2019 — $29bnTTM — $25bn

Last few years of net debt:

2015 — $121bn / 7.25x debt/FCF2016 — $118bn / 6.9x2017 — $114bn / 6.6x2018 — $171bn / 7.4x2019 — $151bn / 5.2x2Q20 — $152bn / 6.1x

Last few years of share count (bn):

2015 — 61452016 — 61392017 — 61392018 — 72822019 — 72552Q20 — 7125

Trailing FCF is >$25bn… Even with the current advertising weakness across the business…

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Here’s a decent litmus test…

  • In 2015-2016, ATT generated $16.7bn and $17bn in FCF with 6.1bn shares outstanding and ~$120bn in net debt.
  • If they can get $20bn total out of all divestitures and lose ~$5bn in FCF during the process that puts them at 7.1bn shares outstanding and $132bn in net debt with $20bn in FCF…

That’s roughly 1bn in new shares x $30 stock price = $30bn + $12bn in additional debt for a ~$3bn boost in FCF or 11x multiple “paid” — not necessarily the worst return considering WarnerMedia is likely a better business than DIRECTV anyway…

Leverage is similar, if not better than, 2015-2016 levels despite a much higher dividend yield today…

I’m convinced most of this centers around the narrative of subscriber losses at DIRECTV and advertising weakness. This story should eventually change as the company delivers on debt paydown and/or selling one or more assets…

(Disclosure: Long AT&T)