Description
AT&T Inc. (NYSE:T) is a provider of communications and digital entertainment services in USA and the world. The Company operates in four segments: Business Solutions, Entertainment Group Consumer Mobility and International. The Company offers its services and products to consumers in the United States, Mexico and Latin America and to businesses and other providers of telecommunications services worldwide. It also owns and operates three regional TV sports networks, and retains non-controlling interests in another regional sports network and a network dedicated to game-related programming, as well as Internet interactive game playing. Its services and products include wireless communications, data/broadband and Internet services, digital video services, local and long-distance telephone services, telecommunications equipment, managed networking, and wholesale services.
Source: Thomson Reuters
Investment Rationale
T looks set to get its approval for its deal to merge with Time Warner (NYSE:TWX). We find the merger to be very compelling, allowing T to produce and distribute their new content across multiple media platforms, perhaps creating their own Netflix like service. The deal is also compelling from a financial standpoint as TWX is a faster growing and higher Free Cash Flow (FCF) margin company. The launch of the new iPhones may also be a nice tailwind for the company. T is trading below its 5 year historical average and is yielding about 5.41%. Along with its strong balance sheet and strong cash flows, we are bullish on T and believe that T is attractively valued at current price
Recent Price Action: T has been struggling since the start of the year when it hit its 52 week high of USD 43.03 in January. Subsequently, the share price continued to tumble to its last done price of USD 36.26, a fall of about 14.74% YTD. Recently, T has shown signs of rallying and closed about 3% above its 52 week low of USD 35.10, which it hit on 8th September.
Merger with TWX: T first announced their intention to merge with TWX late last year, with unanimous approval by the board of directors of both companies. TWX’s library of content is extensive, listing Warner Brothers’ DC franchise (Justice League and Wonder Woman) as well as Home Box Office (Game of Thrones) among its collection. The deal would combine that library of content with AT&T’s ability as one of the largest broadband providers in the USA (3rd largest by subscribers) to distribute that content. T would be able to push TWX content to its mobile and broadband customers and reap the advertising revenue displayed while consumers consume that content. While President Trump had previously stated his opposition to the deal, likely what led to T’s tumble in share price, the review of the merger had reached an advanced stage. While the deal has not yet been approved, we believe that T will eventually be given the approval for the deal to go through.
From a financial standpoint, the merger will also be very beneficial to T. Management has projected about USD 1 bn in cost saving synergies within 3 years of the merger’s completion. With the wireless provider industry in USA facing headwinds and falling revenues, T is not an exception to this, its latest quarter revenue revealed a fall of about 1.8% YoY. TWX, on the other hand, was able to grow its latest quarter revenue by 5.5% YoY. As such, if the merger goes through, T would be taking on a faster growing business.
TWX is also a much less capital intensive business, with a capital expenditure for the trailing twelve months ended in Jun 2017 of USD 472 Mn. In contrast, T is a very capital intensive business, with its capital expenditure for the trailing twelve months ended in Jun 2017 at USD 23.5 bn.
As such, we believe that the merger deal will be very beneficial to T on a qualitative standpoint, the new company having a vast library of content and the means to easily distribute that content, as well as a quantitative standpoint, the acquisition helping to diversify T’s revenue and adding a less capital intensive and higher FCF margin business to T.
5G and iPhone tailwinds: T has also been rolling out its 5G network. With today’s culture of consuming digital content on the go, high speed internet is more important than ever in the bid to attract consumers to subscribe to their services. 5G networks allow consumers to use bandwidth intensive applications like streaming at speeds as high as 1 Gb per second. This also has synergies with their TWX merger, enticing its subscribers to stream its content more often.
Besides that, the launch of the new iPhone X, 8 and 8 Plus will also likely prove to be a significant tailwind for T. T has about 135 mn wireless phone subscribers, and is the 2nd largest wireless phone service provider in the USA. With the release of the new iPhones, we expect many providers, T included, will be offering deals to entice consumers to upgrade their plans and devices. Additionally, with Black Friday approaching, we believe that T will also capitalize on that together with the new iPhones to bring customers in.
With faster wireless internet speeds coming and new devices from Apple, we believe that there are tailwinds behind T to propel its business forward.
Valuations: T closed at USD 36.26. It trades at a PER of 17.04, which is significantly below its 5 year average of 22.31. It has an Operating Margin of 18.38% and a Net Profit margin of 9.83%. Compared to its peers, Verizon trades at a 12.01, Comcast Corporation trades at a PER of 18.72. T pays a div of USD 1.96, representing a yield of about 5.45%, with a payout ratio of 0.78. T is also a Dividend Aristocrat, with a history of 32 years of consecutive dividend increases and is the only telecom company in the list. T has an Interest Coverage Ratio of 5.25 and Free Cash Flows of USD 15.81 bn. Our Target Price of USD X.00 is set based on Technicals.
Technicals: T has been falling sharply since March 2017 and more recently in July after the 200 day moving average capped the bullish recovery. The heavy selling has resulted in the Relative Strength Index (RSI) signalling an oversold condition in August as it fell to an extreme low of 25.6. RSI measures the momentum, and a reading above 70 suggests overbought condition while a reading below 30 suggests oversold condition.
T Daily chart – rebound in sight
Support 1: 35.00 Resistance 1: 37.53
Support 2: 34.00 Resistance 2: 39.67
Red line = 20 period moving average, blue line = 60 period moving average, Green line = 200 period moving average
Source: Bloomberg, PSR
T tends to react well when the RSI is at either extreme. When the RSI reverts to the mean from the overbought or oversold extremes, price tends to enter into a robust reversal.
For instance, in October 2016, the RSI dived into the oversold condition and reached an extreme low of 19.4 on 26 October 2016. Price reversed sharply thereafter signalled by the RSI mean reverting off the 19.4 low. The confirmation of the bottom was when the RSI moved back above 30 on 7 November 2016 with price rallying 14% subsequently.
A similar pattern is happening now after the recent sharp sell-off as the RSI entered into oversold condition. The support off the 35.00 psychological area seems to be holding up firmly for now as price formed a dragonfly doji rejection on 8 September 2017. The bullish reversal continued to work subsequently as price rebounded back above the 36.00 and 61.8% Fibonacci retracement level showing some sign of strength. Moreover, the bullish reversal since 8 September has lifted the oversold RSI back above the 30 range suggesting a mean reversion might be happening.
Hence, we expect the 35.00 psychological support area to hold and a continued sharp rebound to follow through for price to retest the 39.37 resistance area followed by 41.70.
Conclusion: We are bullish on T due to 1) its potential from its merger with TWX, 2) 5G and iPhone tailwinds and 3) its dividend and valuation. As such, we believe that stock has been oversold and with recent signs of recovery, we are bullish.
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