It’s not impossible to make a bullish argument for AT&T (NYSE:T). The company has achieved some positives so far in 2019 the legitimately could give one confidence in AT&T stock.
For one thing, it has reaffirmed guidance, putting to rest suggestions that its recent mega-merger was facing early integration issues. The company is also making progress on paying down debt. Its latest earnings report wasn’t outstanding, as revenues missed expectations, but EPS was good enough.
And yet, AT&T stock has hardly moved. AT&T has only recovered from $29 to $32 since the December swoon, substantially trailing the market as a whole. And AT&T is nowhere near back to where it traded in 2016 and 2017. Back then, AT&T stock regularly sold for $40 or more back before the company levered up to make its bold move into digital content.
Can AT&T Compete In Media?
One troubling sign for investors should be the recent departure of ex-HBO head Richard Plepler. Plepler worked for HBO for 27 years and headed HBO over the last six, overseeing its string of recent successes including the smash hit Game of Thrones.
However, he reportedly felt that AT&T’s management would limit his creative reach. The New York Times reported:
“At some point after AT&T absorbed HBO as part of its $85.4 billion acquisition of Time Warner last year, Mr. Plepler sensed that his ability to run his own shop with his usual swaggering independence was not going to fly under his Dallas-based bosses, two people with knowledge of his thinking said.”
AT&T put one of its longtime executives, John Stankey, in charge of the new WarnerMedia. Stankey suggested that he wasn’t surprised that Plepler and the head of Turner, which runs CNN and TNT, both resigned.
“When you have someone who had a tremendous amount of autonomy, they tend to covet that,” Stankey said.
That’s logical. And it raises real questions about how well AT&T will be able to match up against Netflix (NASDAQ:NFLX), Walt Disney (NYSE:DIS), Comcast (NASDAQ:CMCSA), Amazon (NASDAQ:AMZN) and other potential streaming rivals. We don’t have many historical examples of telecom companies trying to run media operations as well.
AT&T has long been a stodgy company focused on cash flow and paying its out-sized dividend. That’s a very different corporate ethos from the likes of Disney and Netflix, which are willing to make more long-term and risky investments in content and brand-building. AT&T may be able to figure out how to run a dynamic media division inside of a slow-moving utility company. But it’s a risky bet.
Dividend Pressure and AT&T Stock
Another related problem for AT&T is its gigantic debt burden. In fact, after its debt-driven purchases of DirectTV and TimeWarner it is now one of the most indebted companies in the world. AT&T’s debt hit a stunning $183 billion after the TimeWarner deal closed, though AT&T intends to pay off $20 billion or so in 2019 with asset sales and cash flow from operations.
That said, much of AT&T’s profits tend to go to paying dividends, rather than being available for other uses. Over the past 12 months, AT&T has paid out more than $14 billion in dividends. AT&T’s dividend is sacrosanct. The company has continuously hiked the dividend every year since 1985. Additionally, many shareholders only own AT&T stock to get that rich yield, currently in the 6.5% range.
As a result of all this, AT&T cannot realistically cut its dividend. This move would both enrage its yield-loving shareholder base and indicate that the company’s debt position is even worse than most people fear.
Yet, in an alternate world where AT&T wasn’t obsessed with its dividend, it almost certainly wouldn’t choose to set a yield above 6%. Its competition in streaming is willing to spend massive amounts of money to develop their content libraries. Meanwhile, AT&T will be forced to keep a close grip on costs as it manages its large debt and dividend obligations.
AT&T Stock Verdict
I know a lot of investors are tempted to buy T stock here. On an earnings basis, at 11x trailing and under 10x forward earnings, it certainly looks cheap enough. The company’s core telephony business continues to throw off loads of cash. And the company rewards its shareholders with a downright generous 6.5% dividend yield. If we knew that the future would look like that past, T stock would be a screaming deal here.
But technological disruption is a real and present danger. We don’t know who the ultimate winners and losers will be in streaming yet. We do know, however, that assets like HBO and TNT need to adapt, and quickly, to keep prospering in this new media environment.
I’m far from convinced that AT&T has the creative vision to compete against its more nimble rivals. Key employee defections, such as the former head of HBO, add to my concerns.
What will be saying about the AT&T/Time Warner merger in five years if AT&T underinvests in and/or mismanages its new assets? The debt load is simply so huge that they have to execute. Otherwise this cheap-looking stock will turn into dead money for years to come.
In the past, T stock and Verizon (NYSE:VZ) stock traded near the same dividend yield. Now VZ stock yields just 4.3% against 6.5% for AT&T. That shows just how much doubt the market has that AT&T’s new strategy is going to work out. If it does, buyers of T stock today will be well-rewarded. But it’s not hard to see how this mega-deal could end up being a mega-flop.
At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
