AT&T Offers Future Strategic Insights: Key Notes To Consider

As the lines between entertainment and communications gradually blur, AT&T Inc. (NYSE:T) continues to reinvent itself in order to evolve according to the changing consumer preferences. The company has recently offered some key insights into its corporate strategy as to how it plans to better serve customers through an integrated product portfolio, while maintaining a leading position in both these market categories.

Let's delve a little deeper into the broad objectives of the company to help us better comprehend the key issues, before we zero in on an investment decision.

Synergies from Time Warner Acquisition

AT&T completed the acquisition of Time Warner in June 2018 to form a new business division titled WarnerMedia. The company realized that vertical merger was the perfect way to move forward as neither a core communications firm could rely exclusively on content, nor a media firm could solely depend on wholesale distribution models to sustain in a dynamic environment.

With assets like HBO, CNN and TNT, AT&T's acquisition of Time Warner has created new kinds of online videos and opened up avenues for targeted advertisements to counter Verizon Communications Inc.’s (NYSE:VZ) Yahoo (NASDAQ:AABA) and AOL businesses. Given the scale of both AT&T and Time Warner, the merger has reshaped industry dynamics, creating a media behemoth.

AT&T expects to achieve synergies to the tune of $2.5 billion by 2021 from the WarnerMedia assets. These include $1.5 billion from cost synergies related to efficiencies in marketing and procurement and corporate overhead, and $1 billion revenue synergies from additional sales, lower subscriber churn and higher advertising opportunities.

Strengthening of Balance Sheet Position

The company expects to strengthen its balance sheet position by significantly lowering debt burden by utilizing its free cash flow. AT&T intends to lower net-debt-to-adjusted-EBITDA ratio from about 2.8x by 2018-end to 2.5x in 2019. This would involve a debt reduction of $18 billion to $20 billion by next year.

AT&T expects to achieve this milestone by utilizing about $12 billion in free cash flow, with the remainder being resourced through cash generated from real estate sale-lease backs, divesture of non-core assets and other working capital initiatives.

Ramping Up FirstNet Program, 5G Focus

With the bulk of revenues coming from the Mobility business, AT&T aims to ramp up the FirstNet deployment while focusing on 5G technology to retain its leading position in this market. As part of the 25-year contract, FirstNet will provide AT&T with a swath of 20 MHz of spectrum in the 700 MHz frequency band for the entire duration. AT&T will also be given success-based payments of $6.5 billion over the next five years to design and build the network.

The company is expected to spend around $40 billion over the life of the contract to build, deploy, operate and maintain the network. AT&T has projected that this contract will create more than 10,000 jobs over the next two years, offering a significant boost to its profile.

As part of its 5G deployment in a dozen cities in 2018, AT&T aims to launch mobile 5G service in certain areas of five cities — Houston, Jacksonville, Louisville, New Orleans and San Antonio. These add to its previously announced seven cities of Atlanta, Charlotte, Dallas, Indianapolis, Oklahoma City, Raleigh and Waco.

AT&T is further planning to bring mobile 5G service in parts of Las Vegas, Los Angeles, Nashville, Orlando, San Diego, San Francisco and San Jose in early 2019 to take the tally to 19 cities and will expand thereafter. Notably, AT&T’s 5G deployment will entail utilization of millimeter wave spectrum to deploy 5G in pockets of dense. In parts of urban, suburban and rural areas, the company aims to deploy 5G on its mid and low-band spectrum holdings.

New Revenue-Generating Avenues

In order to generate incremental revenues, AT&T plans to introduce subscription video on demand (SVOD) service in WarnerMedia in 2019 along with an advertising-supported video on demand service in the near future. With a three-tier service, including an entry-level movie-focused package, a premium service with original programming and blockbuster movies, and a bundled service package with content from the first two along with an extensive library of licensed content, SVOD is likely to complement WarnerMedia adeptly. This in turn is likely to expand its customer base and open up other avenues to monetize content by leveraging data and analytics to create focused advertising messages.

AT&T also expects to record solid growth in its advertising unit Xandr, whose advanced cross-platform technology enables marketers to trade premium inventory in a transparent and automated environment. This new-of-its-kind advertising company has imbibed four key advantages from its parent firm — data, premium content, advanced advertising technology and distribution network to more than 170 million direct-to-consumer entities across wireless, video and broadband. Leveraging these key drivers, Xandr is anticipated to deliver strong revenue growth in its existing media sales operations in 2019 and beyond.

Our Take

Despite the accretive acquisition of Time Warner assets, AT&T recorded an average decline of 5.4% in the past six months, while the industry witnessed growth of 11.8%. AT&T is facing a steady decline in linear TV subscribers and legacy services. High-Speed Internet revenues are also contracting due to legacy DSL decline, simplified pricing and bundle discount.

Moreover, TV content-cost pressure, high programming costs and new video platform expenses are rapidly eroding margins. Continued cord-cutting remains a perennial challenge as consumers increasingly cancel pay TV packages for cheaper streaming options from Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN), Hulu and other services.

The company continued to witness significant decline in DIRECTV subscribers in third-quarter 2018. With AT&T trying to woo customers with healthy discounts, freebies and cash credits, margin pressures tend to escalate.

The company’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 the cable companies. These are weighing on the company’s revenues and margins.

Moreover, AT&T’s quest for faster growth will increase subscriber acquisition cost in both consumer and SMB (small and medium businesses) units and weigh on wireline margins. Whether all these factors will affect its growth potential in the future remains to be seen.

AT&T currently has a Zacks Rank #3 (Hold).Some better-ranked stocks in the industry are Sprint Corp. (NYSE:S) and Telenav, Inc. (NYSE:T) , both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Sprint has a long-term earnings growth expectation of 19.6%. It surpassed estimates in the trailing four quarters, generating an average positive earnings surprise of 320.8%.

Telenav has outpaced earnings estimates in the last four quarters, the average positive surprise being 12%.

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