EUR 850.00 For Business Accounts Only

Morningstar | T Updated Forecasts and Estimates from 08 Nov 2018

AT&T isn’t making it easy on investors, shuffling businesses between segments to layer additional complexity on top of the Warner acquisition. Looking through the firm’s third-quarter numbers, though, we didn’t see anything to change our long-term view. The wireless business continues to slowly improve, while the entertainment segment looks troubled and WarnerMedia posted solid results. We aren’t big believers in the promised synergies between AT&T’s various businesses, but we still believe the firm overall possess advantages worthy of a narrow moat. We don’t expect to materially change our $37 fair value estimate.

AT&T added 69,000 net new postpaid phone customers during the quarter, a solid improvement versus a loss of 145,000 a year ago. Customer defections and gross additions both increased, which we suspect resulted from the entry of the cable companies into the market and customer retention struggles at Sprint. In addition, pricing changes across the industry have likely prompted more customers to look at changing carriers. On the flip side, AT&T has seen a nice lift in average revenue per customer. AT&T is also executing well on the prepaid side of the business, adding 588,000 net new phone customers in the segment. Wireless services revenue grew 1.9% excluding accounting changes, marking the fourth consecutive quarter of improvement.

The entertainment segment remains a sore spot. The business lost 346,000 net traditional television customers, while DirecTV Now, its Internet-based television offering, added only 49,000 net new customers, down sharply versus the past several quarters. Management indicated that price increases and reduced promotions around Now have stalled growth while making the offering profitable. We agree with the move to rationalize pricing, but we also believe AT&T is fighting against the tide here as the television business fundamentally changes in a way that makes content aggregation far less valuable than in the past.

Entertainment segment revenue declined 6.7%, excluding accounting changes. The Internet access business was the only bright spot in the quarter, posting 3.6% growth in average revenue per customer, but even here customer metrics were weak. More troubling, the segment EBITDA margin continues to drift lower as content costs rise and revenue falls. Management hopes to return this business to EBITDA stability in 2019, but we don’t expect the firm will succeed on this front.

Absent the shift of AT&T’s regional sports networks into WarnerMedia, the media segment increased revenue 6.5% year over year, its best performance of 2018. The Turner networks continue to drive strong affiliate revenue growth, the flip side of the margin pressures in the entertainment segment , and the television studio also posted solid results, with revenue up 22%. It’s still too early to gauge the effectiveness of AT&T’s strategic moves in this business, but we expect Warner will remain a strong player in the media business.

Free cash flow generation during the quarter was solid at $6.5 billion, allowing AT&T to fund $3.6 billion in dividend payments and begin reducing leverage. Net debt declined $1.9 billion during the quarter to $175 billion.