A Bullish Call on AT&T

S&P likes the telecom giant's rising market share in broadband and wireless, and rates the shares strong buy

by Todd Rosenbluth From Standard & Poor's Equity Research

AT&T Inc. (T; recent price, $38) will be hosting an analyst day in New York on Dec. 11, and we expect a positive message will be shared, including higher operating margin targets for 2008. With more than 30% of its revenues derived from wireless services and, in our view, opportunities to gain market share in broadband, we contend that AT&T is well-positioned to generate revenue growth in 2008 despite an economic slowdown. We also contend that as competitors face operational challenges, AT&T will gain market share in wireless and broadband.

In addition, we see opportunities for AT&T to expand its margins from additional cost synergies, including a migration of wireline data traffic to one network, and from improved efficiencies in the wireless segment. We expect AT&T will use its strong cash-flow generation to support a 10% dividend increase in December, 2007, and to fund growth opportunities with capital investment.

Despite expected increased competition in 2008, we view these high-quality shares as undervalued. The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or strong buy.

Company Profile

AT&T Inc. combined SBC Communications with the acquired assets of AT&T Corp. in November, 2005. At the end of 2006, AT&T closed on its acquisition of BellSouth for $86 billion in stock, creating the largest U.S. telecom carrier. As of September, 2007, the combined company had 63 million in-region local phone lines (down 6.9% from a year earlier) and 13.8 million broadband customers. With the acquisition of BellSouth, AT&T took full control of Cingular Wireless (33% of projected 2007 AT&T revenues), the nation's largest wireless provider with 65.7 million subscribers, and expanded its wireline presence into the southeastern U.S. In early 2007, Cingular was renamed under the AT&T umbrella.

The inclusion of AT&T Corp. added voice, data, IP, and hosting services for enterprise customers as well as a national network. SBC expanded through a number of mergers of fellow Bell companies over the past 10 years. Meanwhile, Cingular Wireless began operations through the merger of the wireless operations of SBC Communications and BellSouth. Reported results in 2006 largely exclude BellSouth operations, including its 40% stake in Cingular.

Wireline: On the wireline side (54% of projected 2007 revenues), third-quarter 2007 results for AT&T reflected improved operating efficiencies that helped to drive an expansion of the overall operating margin to 23.7%. This occurred even as total access lines and revenues were restricted by competition from cable companies and wireless substitution. Thus far in 2007, AT&T has reduced costs in part by migrating the voice traffic of the former SBC and BellSouth businesses onto the legacy AT&T Corp. network and bringing its corporate head count down. AT&T expects an additional $5 billion in cost synergies from the BellSouth acquisition in 2008 on top of the $3 billion it should achieve in 2007.

We believe that after giving cable companies a head start in offering a triple play of services, telecom carriers such as AT&T are better positioned to defend their customer bases and expand the average dollar amount spent by a household in 2008 with the launch of higher-speed services and the inclusion of video services in the bundle. Over the longer term, we see telecom and cable companies competing rationally on price.

As of September, 2007, AT&T was providing broadband service to more than 32% of the consumer access-line base, a higher penetration rate than its peers, and we look for the penetration rate to rise to the mid-30% range in 2008. We contend that customers who receive broadband and other nonvoice services from their local telecom provider will be less inclined to churn and will look to the telecom carrier for additional services.

At the end of the third quarter, AT&T reported that 44% of its 13.8 million DSL customers in the consumer and enterprise market had download speeds four times as fast as its basic broadband service and in line with the speed of traditional cable broadband offerings, which we believe have lost some luster.