Description

The ultimate irony: “Dinosaur” AT&T represents the real pricing power, tech superiority and capital return story of the connectivity industry, at a dirt cheap price. Virtually nobody is paying attention, and I think the stock could rise 50% and still be cheap.

Based in Dallas, Texas, AT&T is a leading international provider of telecommunications and technology services.  The company's Communications segment encompasses wireless, wireline, and broadband services in the U.S. and internationally, offering bundled products that utilize shared assets. It includes Mobility (nationwide wireless service), Business Wireline (advanced ethernet-based fiber and other services), and Consumer Wireline (broadband, fiber and traditional voice services). The Latin America segment covers wireless services in Mexico, where its LTE network now covers over 104 million people.  Additionally, in 2021 AT&T partnered with private equity firm TPG Capital to separate DirecTV into a new company, allowing AT&T to retain a 70% common equity interest.  In total, consensus expected revenue growth for AT&T for the next two years is only about 1% per annum, though EBITDA is expected to grow at a 2-3% rate.  

Modern-day AT&T emphasizes connectivity services, particularly in 5G and fiber, building upon a solid spectrum portfolio acquired through FCC auctions.  The hybrid wireline and mobile approach should create growth opportunities as bandwidth demands increase.  The integrated telecommunications network leverages different technologies to provide high-speed connectivity, while the expansion in 5G and fiber networks aims to meet the growing demand for broadband.  As is well-understood by cable and telecom investors, broadband and wireless services are benefiting from rapidly increasing data usage, with the 5G deployment enhancing connectivity and network efficiency.  In terms of broadband technology, the company identified fiber as a core priority in 2020, with significant customer growth in fiber broadband, a technology (in which data is transmitted with flashes of light through strands of glass) that can beat cable internet by providing consistent, reliable multi-gig speed services to customers at an attractive price.  

By reputation, AT&T is a dinosaur and a relatively unexciting company.  So, why have I chosen to invest here?  Two primary reasons.

• Price increases.  As I have written extensively about other situations, I believe that pricing power is the single most important characteristic of a successful business.  Pricing power conveys critical information about a product’s value proposition, customer satisfaction, the availability of alternatives, switching costs and demand elasticity.  In July 2023, I noticed an article stating that AT&T had raised wireless prices for the second time in the first seven months of the year.  The company was also raising internet prices.  Then, I saw my own wireless bill in October jump 9.8% from the prior two months and 11.7% from three months prior.  This magnitude of price increase struck me as a very positive sign for AT&T, particularly given its large infrastructure base, built with “old dollars.”

• Deleveraging.  Owing to heavy capital deployment over the last decade driven by share repurchases and capital expenditures, investors have become increasingly concerned about the company’s debt load, which had expanded from 1.5x net debt/EBITDA to nearly 3.2x by early 2021.  Notably, cable companies such as Charter Communications typically pay no dividends but often repurchase stock and run with 4.5x+ leverage.  After 20 years of poor shareholder returns, AT&T’s management seems to understand the issue and is now focused on both increasing free cash flow and deleveraging.  With AT&T (and competitors, such as Verizon and T-Mobile) successfully taking price increases while having made large capital return promises to shareholders, the industry seems to be in a rational competitive place.  With third quarter earnings, CEO John Stankey increased the company’s 2023 free cash flow guidance to $16.5 billion and said, “This takes us to the final priority, and that's how we're putting our improving operating leverage to work. In the third quarter, we reduced our net debt by more than $3 billion and are on track to achieve our 2.5x net debt-to-adjusted EBITDA target by the first half of 2025.”  With a current annual dividend of $1.11 per share (an implied 6.6% yield), increased free cash flow (to an estimated $2.29 per share in 2023) and reduced leverage could meaningfully improve both investor confidence and equity value.

In sum, the setup in AT&T shares feels unusually attractive to me given the combination of (i) a low valuation multiple, (ii) pricing power in wireless, (iii) fiber internet competitiveness and (iv) balance sheet deleveraging.  If pricing flows through and revenue grows slightly faster than markets expect, we could be rewarded.  Should the company’s valuation expand to about 7x 2024 EBITDA, an implied 10% free cash flow yield to the equity, AT&T equity value per share would rise to about $24, implying a future dividend yield a bit below 5%, all else equal.

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.  Please do your own research.

Catalyst

You guys keep paying your bills and keep switching to fiber internet, because it's far better.