Frontier to gain AT&T’s phone and U-verse TV and broadband subscribers
AT&T Inc. (NYSE:T), the largest phone company in the US, has sharpened its focus on its highly profitable wireless business. As part of its larger plans to give its wireless business undivided focus, AT&T has agreed to sell its Connecticut wireline assets to regional telephone operator Frontier Communications for $2 billion in cash. The deal comes at a strategic time when most households in the US are opting for wireless services over the traditional line phones.
For Frontier, the biggest deal sweetener would be its gain of AT&T’s phone customers, U-verse TV and broadband subscribers, and satellite-TV users in the state. Moreover, the acquisition of AT&T’s wireline business would improve the financial health of Frontier in terms of boosting its dividend payout ratio, generating savings, and improving its adjusted free cash flow. The transaction is expected to be completed in the second half of 2014.
Taking the leap to wireless
Over the past few years, AT&T’s revenue from landline operations has steadily been falling. In 2007, the landline business accounted for 59% of AT&T’s overall revenue. In Q3 2013, this business accounted for 54% of the overall revenue, prompting the management to shift focus to more lucrative businesses and hive off its landline business. AT&T traditionally offered landline services under the brand Ma Bell and was the dominant provider of landline phone service in the US, almost monopolizing the market with its wide reach and high-quality services. Moreover, exiting its Connecticut wireline business bodes well for AT&T’s growth as Connecticut is the only state in the US Northeast where it operates traditional phone service. Its main operations are in the South and Midwest part of the US.
On December 16, AT&T sold its wireless towers to Crown Castle for $4.83 billion. AT&T will use the proceeds of this and the sell-off to Frontier to fund its ongoing upgrades of its wireless and wireline networks as well as its ambitious European expansion plans. The chart below shows AT&T’s price movement since 16 December.
Overseas expansion plans
AT&T is chalking out a strategy for a possible takeover of Europe’s largest mobile carrier Vodafone Group Plc (NYSE: VOD), as part of its expansion plans into the European wireless market. Currently, the European market is witnessing a slow pace of advanced wireless adoption, thereby offering a perfect opportunity for AT&T. According to Bloomberg, AT&T is also eyeing UK carrier EE as an alternative acquisition.
Wireless is AT&T’s cash cow
Earlier this year, the Dallas-based company agreed to acquire Leap Wireless International Inc. (NASDAQ: LEAP) as part of its game plan to add wireless customers.
During Q3, AT&T reported strong wireless revenue growth and postpaid ARPU gains, and continued to expand its highly profitable smartphone user base. AT&T’s total wireless subscribers grew to 989,000 in Q3.
What’s in it for Frontier
AT&T’s sell-off would give Frontier 415,000 broadband connections and 900,000 voice customers in Connecticut. However, an important outcome of the deal for Frontier would be the rise in free cash flow per share in the first year. The deal would also result in $200 million in annual cost savings for Frontier. About 2,700 landline employees from AT&T’s operations in Connecticut will join Frontier, according to the company statement.
The way forward
The deal will need to be approved by the US Department of Justice, the Federal Communications Commission, the Connecticut Public Utilities Regulatory Authority, and other state regulatory agencies.
In the meanwhile, AT&T will be faced with more important tasks on hand – to ward off competition from Verizon Communications Inc. (NYSE: VZ) and cable providers such as Comcast Corp. (NASDAQ:CMCSA). On another note, AT&T will also invest $14 billion over the next three years to improve its networks in a bid to offer better services and thereby garner more number of wireless customers.
WSA on AT&T
AT&T’s changed focus towards the booming wireless business, solid third-quarter profits, backed with strong subscriber growth and record smartphone sales depicts a promising future for the company. However, AT&T is also facing increased competition in the wireless industry as smaller rivals like T-Mobile US Inc. and Sprint Corporation pose a threat through their marketing investments and increased networks.
WSA revised its revenue growth estimate for AT&T to 2.2% and adjusted EPS target for FY 2013 and FY 2014 to $2.46 and $2.70, respectively. Based on our forward P/E multiple of 13.8x, we value AT&T at $37 with a Neutral rating.