AT&T (T, Financial) has been reincarnated time and time again. Ever since its founding in 1880 as the Southwestern Bell Telephone Company, it has had to reinvent itself many times over in order to keep up with technology and changing consumer preferences. The last few years have been one of these transition periods -- it is now time to see whether the results will pay off.
Modern problems require modern solutions
With its legacy wireline and cable TV businesses declining, management has been looking for ways to bring the company into the future, and seemed to have settled on pivoting AT&T into a kind of hybrid content distributor and creator. AT&T’s acquisitions of DirecTV in 2015 and Time Warner in 2018 have been the central pieces of this transformation. Needless to say, this is a pretty crowded space, with Netflix (NFLX, Financial) being the most obvious obstacle, not to mention Amazon (AMZN, Financial)'s Prime, and Disney (DIS, Financial)'s new streaming service.
AT&T’s wireless phone segment is still the most important part of the company, accounting for 40% of revenue and 60% of earnings. Management seems to be hoping that its ability to provide wireless service will set it apart from its competitors in the streaming space, and conversely, that its proprietary content will give it an edge over its competitors in the connectivity sector.
Value or value trap?
On the face of it, AT&T looks like an attractive prospect for an income portfolio. With a price-earnings ratio of 9 and a current dividend yield of over 6.5%, it looks like a bargain. For comparison, Verizon (VZ, Financial), its main competitor, has a current ratio of 12.5 and a yield of 4%. However, there is always a reason for such discounts.
A major concern for would-be AT&T investors is its extremely high debt load. The merger with Time Warner pushed net debt to $180 billion, which at the time was 3.7x Ebitda. Investors are acutely aware of the strain that servicing this load may put on the company’s cash flow, which explains its relatively high yield.
However, AT&T has taken aggressive steps towards paying down its obligations. Since the merger, it has managed to pay off $9 billion, and plans to erase between $18 billion and $20 billion before year-end, which would bring debt to within 2.5x Ebitda. It has been able to do so by selling a number of assets that sit outside its main business, such some real estate holdings, and its stake in streaming service Hulu. Management is hoping that this concerted effort will prove to allay fears of a dividend cut. After all, AT&T has a long history of increasing payouts to shareholders, with almost 35 years of annual increases.
Summary
The big question for AT&T are whether it can continue to milk its declining legacy businesses for enough time to allow it to pay down the mountain of debt it has accumulated in its quest to reinvent itself as a company. Then there is the additional question of whether the current dividend is sustainable. If management is able to come through on its stated goal of a 2.5 debt-Ebitda ratio by the end of 2019, then we should see investor confidence recover.
Disclosure: The author owns no stocks mentioned.
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