AT&T Inc. T had a disappointing 2017 and continues to struggle in the competitive and almost-saturated wireless market. Adoption of several unlimited data plans resulted in a reduction of wireless service revenues and average revenue per user (ARPU).
We believe that the U.S. telecom behemoth is currently facing several headwinds. We do not foresee any immediate catalyst for AT&T’s growth and therefore it will be beneficial for investors if they stay away from this stock.
Question Mark on Time Warner Deal
On Nov 20, 2017, the U.S. Department of Justice (DOJ) filed a lawsuit against AT&T for its proposed $85.4 billion takeover of media giant Time Warner Inc. TWX. The DOJ verdict was challenged by AT&T in court. However, a court ruling is unlikely before May 2018. Notably, both the companies have resettled the closing date for the deal for Jun 21, 2018.
If the court ruling goes against AT&T, three options will be available – scrapping the deal, divesting its DIRECTV division or acquiring Time Warner without the Turner Broadcasting assets including CNN.
We believe that disinvestment of DIRECTV is out of question as the company is gradually promoting its satellite-based DIRECTV brand over its fiber-based U-Verse, as its new pay-TV offerings. Moreover, DIRECTV NOW online streaming service is quickly gaining market traction, which recently surpassed one million subscribers.
On the other hand, disinvestment of Turner Broadcasting assets including CNN will prevent AT&T to derive maximum synergies. Management expects the deal to be accretive to both adjusted earnings and free cash flow, in the first year post its closure. The company is likely to achieve cost synergies of $1 billion per annum within the first three years of the merger. The company expects the deal to help in diversifying its revenue mix, lowering capital expenditure and reducing regulatory restrictions.
Finally, if AT&T abandons the Time Warner deal, it will be the company’s second big ticket merger that will fail after the FCC discarded its $39 billion merger proposal with T-Mobile US. AT&T’s growth in 2018 will largely depend on the court ruling on the Time Warner merger deal.
Intensely Competitive U.S. Wireless Market
The U.S. wireless industry is likely to get competitive in 2018 with the entry of cable MSOs (multi service operators). Comcast has already entered this space with its Xfinity Mobile offering. Charter Communications has reiterated its plans of launching wireless service in the first half of 2018.
Technological upgrades and breakthroughs have resulted in cutthroat price competition. Although AT&T added domestic postpaid wireless customers in the third quarter of 2017, a closer look gives us a more interesting picture. Net addition of 117,000 postaid connections actually dropped a substantial 44.8% year over year. Notably, postpaid customers are those who are billed monthly and considered more profitable to telecom operators.
Moreover, AT&T’s wireline division is struggling with persistent losses in access lines as a result of competitive pressure from voice-over-Internet protocol (VoIP) service providers and aggressive triple-play (voice, data, video) offerings by cable companies. These are weighing on the company’s revenues and margins.
Cord-Cutting a Major Concern
In the third quarter of 2017, AT&T lost 251,000 satellite TV customers and 134,000 U-verse TV customers. Of late, the legacy pay-TV industry has been facing stiff competition from online video streaming service providers. The low-cost over-the-top video streaming service has resulted in massive cord cutting that is currently threatening the pay-TV business model.
A major cause for concern for pay-TV operators, who recently entered into Internet TV streaming, is that the latter has actually cannibalized the legacy pay-TV service. Most of these companies are offering both legacy pay-TV services as well as Internet TV streaming service, with selected TV channels at lower costs.
Operators are yet to find out an appropriate trade-off between these two types of services. Making attractive online ventures are drawing subscribers to the new service at the cost of traditional pay-TV business model. Ultimately, the Internet TV service is yet to stop cord-cutting, the biggest threat for pay-TV operators.
Other Headwinds
At the end of the third quarter of 2017, AT&T had approximately $163.3 billion of total debt outstanding with a debt-to-capitalization ratio of 0.55. Its debt skyrocketed post its decision to acquire media mogul, Time Warner Inc.
In November 2017, Mexico’s telecommunications regulator stated that America Movil could start charging local rivals for mobile calls to its network for the first time since a 2014 sector reform. This has been a bane for companies like AT&T which are desperately trying to strengthen foothold in Mexico but still depend on America Movil’s network due to its sheer size across the nation.
AT&T is aggressively offering bundled services. However, it needs to set the stage right, as so far, its bundled customer addition has failed to match the outflow of users from its legacy services. Our analysis has been substantiated by the fact that over the past 60 days, five analysts have downwardly revised their estimates for 2018 Earnings per share (EPS) of AT&T.
Price performance and Zacks Rank
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In 2017, AT&T’s shares have decreased 9.89%, worse than the industry’s decline of 8.14%. Notably, the benchmark S&P 500 index has gained a whopping 18.25% in the same time period. AT&T carries a Zacks Rank #4 (Sell). However, other major national carriers, namely Verizon Communications Inc. VZ, T-Mobile US Inc. TMUS and Sprint Corp. S carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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