Valuation by Rajiv Singh
Slow Pace of Advanced Wireless Adoption in Europe Offers Opportunity for AT&T
AT&T (NYSE: T), the largest phone company in the US,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. While it seems like the deal may not be finalized until 2014, AT&T is considering how best it would manage Vodafone’s European operations if it does go ahead with the deal. Earlier, Verizon and AT&T were looking to jointly bid for Vodafone, with Verizon reclaiming Vodafone’s $130-billion stake in Verizon Wireless, thereby allowing AT&T to take over the company’s European business. However, Verizon rejected that approach since it could slow down its $130 billion purchase of Vodafone’s 45% stake inVerizon Wireless.In a parallel development, Vodafone plans to invest in landline communications, which a might turn AT&T off a probable deal.
Possible Merger Could Create a Global Telecom Behemoth
A possible merger would create the world’s largest telecom operator by sales, according to Bloomberg. The combined entity would be a global player with a market capitalization of over $250 billion and widespread operations in the US and Europe. With a global wireless subscriber base of 500 million, the merged entity would be able to effectively compete with Google Inc. and Apple Inc. when negotiating for handset subsidies. It would also be able to have the first mover advantage with nascent technologies such as mobile advertising.
Top 10 Telecommunication Operators Worldwide in 2011Based on Sales (in millions euro)
AT&T Could Spin-off Vodafone’s Assets in Emerging Markets
In the scenario of a possible merger with Vodafone, AT&T would first have to overcome the daunting task of offloading some of Vodafone’s diverse assets in the emerging markets such as India and Africa. It is interesting to note that Vodafone is seeking to take full control of its Indian unit, a move that could complicate the merger. Industry experts believe that AT&T is mullinghiving off most of Vodafone’s emerging-market assets into a new entity that could be acquired by a single buyer. Potential players being considered for such a move would be America Movil or China Mobile Ltd. AT&T already owns a 9% stake in America Movil. France-based Orange, which operates in Kenya and Senegal in Africa, has also evinced interest in buying some of Vodafone’s African operations. On a negative note, AT&T’s merger or takeover of Vodafone could attract political opposition in the UK.
Asset Monetization, Selling Towers
In another development, AT&T recently announced the sell and lease of its towers to Crown Castle for $4.85 billion. This deal includes a sale of 600 towers and a 28-year lease for 9,100 towers. The proceeds received from the deal willbe a great opportunity for AT&T to fund its expansion plans, reduce leverage or support its repurchase program. However, it won’t be possible for AT&T to fund the $130-billion Vodafone deal using the $4.5 billion proceeds from its tower sell deal with Crown Castle.
Third-quarter Results- Key Takeaways
AT&T reported solid Q3 results with strong revenue and earnings growth driven by rapid strides in mobile and IP data, U-verse, and strategic business services.Consolidated revenues totaled $32.2 billion, up 2.2%as compared to the year-ago period. Net income grew to $3.8 billion compared to $3.6 billion in the year-ago quarter. Earnings per share rose by 14.3% to $0.72 per diluted share compared to $0.63 per diluted share in the year-ago quarter.During Q3, AT&T added nearly one million subscribers, reported strong wireless revenue growth and postpaid ARPU gains, and continued to expand its highly profitable smartphone user base.
In its Wireless segment, AT&T reported 5.1% growth in total wireless revenues to $17.5 billion compared to the year-ago period as shown below. Wireless service revenues increased by 3.7%to $15.5 billion and wireless data revenues by 17.6% to $5.5 billion. Wireless operating expenses grew by 5.7% to $12.9 billion and wireless operating income rose 3.4% to $4.6 billion compared to the year-ago period.Wireless margins reflect record Q3 smartphone sales, robust upgrades and revenue growth from the company’s high-quality smartphone subscriber base.
Looking at APPU, total postpaid subscriber ARPU grew a little by 1.5%compared to the year-ago period. AT&T’s total wireless subscribers grew to 989,000 in Q3.The company also added 1.2 million postpaid smartphone subscribers in Q3.Postpaid churn, a metric followed by industry experts, was down slightly to 1.07% compared to 1.08% in the year-ago quarter and increased from 1.02% in Q2. Total churn was 1.31% versus 1.34% in the year-ago quarter and 1.36% in Q2.Wireline revenues were driven by U-verse amassing 10 million subscribers, wireline consumer revenue growth, and a steady rise in strategic business services.
WSA on AT&T
AT&T’s expansion plans in Europe, solid third-quarter profit backed up with strong subscriber growth and record smartphone sales depicts a promising future for the company.However,AT&T is facing increased competition in the wireless industry, as smaller rivals like T-Mobile US Inc. and Sprint Corporationpose a threat through their marketing investments and increased networks.
AT&T reported lower-than-expected revenue in Q3 2013, mainly on account of higher capital investments.AT&T’s consolidated revenue grew just by 2.2% y/y,much lower than Verizon’s 4.4% and Sprint’s 5% y/y revenue growth during Q3.
Operating margin has been under pressure; especially for the Wireline business segment where operation margin fell to 10.2% as of Q3 2013 from 12.1% a year ago, primarily due to customer growth related costs and costs incurred as part of project VIP capital investment.
AT&T’s stock repurchasing and capital expenditure plans have encouraged Moody’s and S&P to review its current corporate debt rating. According to Moody’s, if AT&T pursues it $120-billion purchase plan of Vodafone, a 50% funded deal will attract a one-notch rating downgrade to Baa1 from the current A3 rating.
In light of a possible high leveraged Vodafone acquisition plan, weak revenue growth and stiff competition, WSA revised its revenue growth estimate for AT&T to 2% and adjusted EPS target for FY 2013 and, FY 2014at to$2.48 and $2.68, respectively. Based on our forward P/E multiple of 14x, we value AT&T at $38 with a Neutral rating.