AT&T's Two-Year Restructuring Journey: A Focus on 5G and ...

AT&T's Two-Year Restructuring Journey: A Focus on 5G and Fiber Networks

Over the last couple of years, AT&T has actively undertaken a restructuring process by divesting its non-core assets and initiating spin-offs of DirecTV and WarnerMedia. The company's primary goal has been to realign its focus and prioritize the enhancement of its 5G and fiber networks, positioning itself for a more competitive stance in the telecommunications industry.

A significant milestone in this strategic plan was the successful merger between WarnerMedia and Discovery, resulting in the formation of Warner Bros. Discovery (WBD 0.16%). The transaction, completed on April 8, 2022, allowed AT&T investors to receive 0.241917 shares of WBD for each AT&T share they held. However, since both stocks began trading separately on April 11, both AT&T's and WBD's stock prices have experienced declines, with AT&T's stock falling by 25% and WBD's stock dropping by 47%.

Initially, the "new" AT&T impressed investors with robust growth in its wireless business, gaining nearly 2.9 million postpaid phone subscribers in 2022 and expanding its fiber networks. However, this growth was dampened by underperformance in its business wireline segment and the loss of non-fiber broadband customers. Consequently, AT&T revised its initial projection of $20 billion in free cash flow (FCF) for 2023 down to $16 billion. In the first quarter of 2023, the company generated only $1 billion in FCF due to increased expenses related to 5G and fiber.

This sluggish FCF growth has raised concerns about AT&T's dividends and expansion plans, causing investors to seek more conservative income investments amidst the prospect of rising interest rates. Despite seemingly attractive valuations at six times forward earnings and an impressive forward yield of 8.3%, there are three other red flags that could potentially limit its short-term gains.

One such concern is the possibility of Amazon's entry into the wireless market. Reports in early June suggested that Amazon might introduce wireless plans at an exceptionally low price, even possibly free for its Prime members. While Amazon later refuted these rumors, the idea of their potential collaboration with one of AT&T's primary competitors raised concerns, especially amidst an ongoing price war among major U.S. carriers.

Furthermore, AT&T's CFO Pascal Desroches cautioned that the company might fall short of expectations for adding postpaid phone subscribers in the second quarter, casting doubts on its ability to reach the targeted $16 billion in FCF for the year. Although AT&T's performance still surpassed Verizon, doubts are growing about its FCF prospects.

Moreover, AT&T, along with Verizon, faced scrutiny over a Wall Street Journal report alleging exposure of workers and the environment to toxic lead-sheathed copper cables. The potential cost of replacing these legacy cables could be significant, and though AT&T claims they constitute only a small portion of their network, ongoing coverage of the issue may impact the company's brand reputation and stock price.

Looking ahead, AT&T's second-quarter earnings report, scheduled for release on July 26, is expected to reveal weaker-than-expected wireless numbers and may provide updates on the lead-covered copper cable issue. Demonstrating higher-than-anticipated FCF growth could offset some negative sentiment, but in the current uncertain market, AT&T's stock may continue to trade at a discount until additional positive indicators emerge.