Update as of May 2021. AT&T decided to sell the only positive aspect (from my point of view). I sold out all my shares.
AT&T is made up of the following segments:
- Mobility, which provides U.S. wireless service and equipment.
- Entertainment Group, which provides video, broadband, and voice services to residential customers.
- Business Wireline, which provides IP-based, voice, and data services to business customers.
- Turner, which operates basic television networks and digital properties, and largely makes advertising revenue.
- Home Box Office (HBO), which provides premium pay TV and internet streaming content.
- Warner Bros., which produces, distributes, and licenses TV shows, movies, and games.
- Latin America, which provides wireless and satellite services to Latin America and the Caribbean.
How are the segments doing?
- Mobility: Slow and stable growth with lower churn, benefitting from investments in network quality and its FirstNet first-responder network. Covid-19 impacted service and roaming revenues, but excluding this, AT&T’s largest segment looks strong and stabilized.
- Entertainment Group: This is the division most investors are concerned about, declining at a rapid 10% clip.
- Video entertainment is declining 12% year over year, which is traditional Pay TV and Premium TV, is bleeding quite aggressively as consumers continue to “cut the cord” and shift towards a la carte streaming services. The lack of live sports this year hasn’t helped Pay TV either.
- Legacy voice and data services are also declining and should be thought of as an eventual zero.
- High-speed internethas been stabilized and AT&T continues to grow and penetrate their fiber internet offering quite well.
- Business Wireline: This division is seeing slight declines of 2.5% offset by new strategic and managed services and cost initiatives. This is actually quite impressive, given how many businesses have been “work-from-home” this year. I consider this a stable business, but not also particularly attractive.
- Turner Media: AT&T’s television business is up 5.6% year over year from strong advertising and content revenues.
- Home Box Office (HBO): HBO is down 2.1% in Q3 from lower licensing revenues and is carrying higher costs from the launch of HBO Max. HBO Max subscribers are growing while traditional linear HBO subscribers are declining.
- Warner Bros.: Warner Bros. is down 27.7% due to the postponement of movie and television production and releases because of the pandemic. In a content-dominated world, this is a really attractive long-term asset that should bounce back once the pandemic subsides.
- Latin America: This segment is actually seeing improving subscriber trends, but is down around 20% mostly because of the strengthening US Dollar.
Why are we buying AT&T stock?
The company looks like they are making headwind on bringing AT&T to the modern era, a strategy focused on investing heavily behind fiber internet, 5G, and HBO Max.
Fiber internet has stabilized the broadband business and will return it to growth.
- As the world moves more and more towards services streamed over the internet, high speed internet will become more and more important for households.
- I am less convinced that all households will move to “5G Modems”, although I think T-Mobile is going to do very well being aggressive here. In reference to 5G “broadband”, AT&T’s SVP of Wireless Technology Igal Elbaz said at a recent 5G summit, “We’ve never seen the economics of building a stand-alone millimeter wave for broadband”.
- Elbaz also said “fiber provides you with a really long-term return on your invested capital. And what’s important, and we’ve seen this in COVID, our customers love of fiber service because…it’s fast. It’s reliable. It’s symmetric…we’re seeing the growth in uplink over twice the growth in downlink”.
- As upload speeds (in addition to download speeds) become more important, fiber will do well and I am underwriting fiber stabilizing AT&T’s broadband business and returning it to modest growth.
Wireless is performing well and presents opportunity during the 5G transition.
- My research has shown that AT&T is in a strong position in the upcoming 5G transition and has a chance to claw back some of Verizon’s ($VZ) lead in wireless.
- In Q3, AT&T had its best postpaid mobile net adds in seven years, which suggests the improved network performance and capacity and sales execution is working.
- AT&T is also seeing dividends from building out their FirstNet network, and it continues to contribute to subscriber gains.
Traditional Pay TV will continue to decline to insignificance, but AT&T TV presents an opportunity to mitigate or even grow the TV business.
- AT&T TV was launched in March and is an internet-connected TV client that offers live TV packages, cloud storage, access to other streaming apps, and other smart-device features like Google Assistant.
- Guidance on AT&T TV is that it is very popular with customers, and indeed I like my AT&T TV experience.
- AT&T TV is being sold with fiber internet and HBO Max in bundles, which I believe will be the future for high-speed households.
- This product meaningfully lowers the cost of TV installs for AT&T and iss now their lead TV product.
- AT&T TV looks like it could help stymie the bleed of Pay TV declines and potentially stabilize the business, as pricing is competitive with streaming services like YouTube TV, Hulu + Live TV, etc. And being a light internet box bundled with internet, set up is almost as easy as the competition too.
- Furthermore, I believe there is optionality with AT&T TV Now, which is their direct streaming TV competitor to Hulu + Live TV, YouTube TV, etc. If they can figure out how to successfully market this product and the category grows, it could provide us investors upside optionality.
HBO Max is a strong product being marketed well and can take a Top-3 spot in a la carte streaming services, behind Netflix and Disney+.
- HBO Max leverages the extremely valuable content that AT&T owns, such as Turner, Warner Bros, and HBO. They are even committing to launching Warner Bros. movies on the platform on the same day as theaters.
- Original content is king in the new streaming world, and HBO Max has that in spades. We should expect even more new original content to hit HBO Max next year, which should also help boost subscriber growth.
- The HBO platform (legacy HBO + HBO Max) now has over 38 million U.S. subscribers, up 15% from Q1 2020. And this performance is before it launched on Roku, which is just did.
- AT&T is planning to launch an ad-supported version of HBO Max next year, which should help drive further subscriber growth by reaching the lower-cost part of the market.
- I believe HBO Max is trending above AT&T’s goal of 50 million domestic HBO subscribers and 75 to 90 million global subscribers by 2025, and will deserve to be worth at least 25% of Netflix.
- HBO Max growth will also be a performance catalyst that can push up the stock price in the mid-term.
What about their debt and dying assets like DIRECTV?
- AT&T doesn’t have a particularly onerous debt burden at this point, with net leverage of 2.7x EBITDA and an interest coverage ratio (EBITDA / interest) of 5.75x.
- Furthermore, management is reviewing the monetization and divestiture of non-core assets. We as investors hope that they can divest some of these assets to shore up their balance sheet.
- AT&T is in the thick of trying to sell DIRECTV, which you can read about here.
- It looks like they’re getting offers over $15 billion for the division, yet are dissatisfied with the offers for the business.
- This actually makes sense, as $15 billion only represents 2.3x my estimated DIRECTV EBITDA of ~$6.5 billion.
- For conservatism, I am assigning a 3.0x EBITDA valuation to the dying businesses, which implies they can just run it for cash over 5 years.
What about Elliott Management selling their stake?
Elliott Management’s Letter to AT&T (Sep 9, 2019)Download
I’ve read Elliott Management’s letter to AT&T, and in general, I don’t believe Elliott’s thesis affects our investment thesis. We do not know why Elliott has sold its stake, so I am cautious, but I also generally don’t “follow the leader” with investments.
- AT&T looks committed to some of the feedback Elliott had last year with divestitures and reeling back frivolous acquisitions.
- New CEO John Stankey has a clean slate in my eyes to prove that the company can invest successfully behind growth (5G, Fiber, HBO Max), while being disciplined with capital.
What’s the valuation and upside?
AT&T is trading for an attractively low valuation, with multiple possible upside scenarios and limited downside.
If HBO Max takes off and grows in popularity, my price target today for $T stock is $39 per share based on a sum of the parts valuation.
- The Wireless business should be worth around $220 billion.
- Verizon ($VZ), T-Mobile ($TMUS), and Sprint ($S) are trading at 7.5x, 9.5x, and 6.5x EBITDA, respectively, based on momentum and market position.
- I am assigning a relatively conservative 7.0x EBITDA to AT&T’s wireless business.
- The run-rate Broadband and Media business should be worth around $90 billion.
- Broadband and media peers Charter Communications ($CHTR) and Comcast ($CMCSA) are trading for 12x and 11x EBITDA, respectively.
- I am assigning a relatively conservative 9.5x EBITDA to AT&T’s broadband and media businesses.
- Wireline and Latin America should be worth more than $60 billion using a conservative 6.0x EBITDA multiple.
- Pay TV and Legacy segments should be worth around $22 billion if you assign a “run for cash” 3.0x EBITDA multiple.
- HBO should be worth over $75 billion if it can gather 80 million subscribers at 80% of the EV/subscriber of Netflix. Subscriber value could be higher with HBO being priced as a premium product.
Adding the valuations up and subtracting corporate costs and eliminations gets me to a potential $446 billion Enterprise Value, or $277 billion Equity Value, for AT&T.
That represents a $T price target of $39 per share, 36% upside potential from its current price of $28.60, all while getting paid an additional 7.3% return in the form of dividends.
- If HBO Max is the catalyst for AT&T stock reaching the high $30’s per share in two years, $T could provide us with 25% total annual returns.
- I see potential additional upside through $6B in cost transformation items that management has identified.
I also see limited downside from here.
- Even if you assume no valuation multiple recovery, writing Pay TV and Legacy as worthless, and HBO only worth $20 billion at a base level, the stock should be worth around $25. That would represent a 12.5% price decline, which would be offset by dividend returns.