AT&T: At The Right Price And Valuation Compared To Peers (NYSE:T)

T-Mobile US (TMUS), Verizon (VZ), and AT&T (NYSE:T) have had very different paths the last ten years. The only one of these you could have owned and had any bragging rights with is TMUS, which basically arose from the dead under John Legere to become one of three major telcos. As the TMUS CEO noted at recent UBS 50th Annual Global TMT Conference, TMUS had actually lost 2.2 million postpaid customers in 2012. TMUS was emerging from a failed merger with T and had a potential merger with Metro PCS on the table. In this environment, TMUS produced a strategy focused on the customer and growth that allowed them to survive and thrive. The major elements of that strategy were

–A mobile only approach by a focused and driven team

–Focus on the top 50 markets in the US—take share

–Aggressive and simplified pricing to produce best value even if it meant lower margins

–Acquisitions, such a Sprint, that were in their swim lane and that brought customers and spectrum assets

–An asset light strategy that featured leases for spectrum and back-haul fixed line

–Differentiation of brand, the Un-carrier, 5G leadership, and customer friendly policies

–Control of critical spectrum for 5G

With this strategy, the TMUS customer base exploded upward and TMUS stock price went from a low of $16.00 in 2013 to a closing price of $142.36 on Dec 16, 2022. It was a growth stock, without a dividend, that grew its earnings from $0.05 in 2013 to an E$6.70 this year (source Valueline). And along the way its PE has reflected its growth prospects—today being more than double that of VZ and T. If it were not for this difference in valuation and the fact that the past is not always prologue, this article could stop right here.

While T has recently had a major shift in strategy, the last ten years has been pretty much characterized by mistakes. These started with a huge share repurchase program in 2012, repurchasing $27B of its shares through 2014 at prices in the mid-30s and pushing its leverage up (Source Morningstar). In 2015, T purchased a satellite TV business, DirectTV, when the business was peaking in maturity. Its expansion into Mexico and its acquisition of Time Warner, while still paying a sizeable divided, all left it in a weakened financial position to advance its core business. It was left with the need to acquire spectrum at a high price as it did at the recent C-band auction, to reduce its dividend, and to make asset sales. In short, it had to achieve focus on its core business or continue to suffer. And shareholders have suffered over the last decade, as the stock has returned 2% annually, even after adjusting for dividends.

VZ has done a significantly better job than T at capital allocation. While it did make some money losing forays into the media business with AOL and Yahoo, the losses were not on the scale of T’s. Further, VZ disposed of some of its local telco assets to FairPoint and Frontier in a timely way that created value for VZ. Verizon FIOS in the Washington to NY corridor, though not a hit on the media level as people cord cut and moved to streaming, did deliver a fiber optic core to a huge customer base. VZ, much as T, paid dearly in the recent C-band auction. Also, as with AT&T, this buy was necessary to protect its future. More recently VZ acquired prepaid wireless reseller Tracfone from America Movil. More on that when I get into the future strategy of each of the three telcos. VZs average annual returns over the last decade (7%) have been considerably better than T’s (2%) and considerably worse than TMUS (23%).

Capital Structures and Finance Need Careful Consideration

When I first started to compare the three companies’ finances, I was of the opinion that if I dug deep enough, I would find some key pieces of information that would allow me to favor one or the other in a decisive way. This has not been the case. Eventually, I resorted to a “keep it simple” philosophy as the three companies are all rated as investment grade by all three major ratings agencies with VZ having a slight edge, when one starts adding up things like pluses and minuses.

Credit Ratings of Telcos
	AT&T		VZ		TMUS
	Rating	Outlook	Rating	Outlook	Rating	Outlook
Fitch	BBB+	Stable	A-	Stable	BBB-	Positive
Moody	Baa2	Stable	Baa1	Stable	Baa3	Stable
S&P	BBB	Stable	BBB+	Stable	BBB-	Positive

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And while the largest amounts of debt at T and VZ capture one’s attention, all three have debt levels about equal to their annual revenues. So, conversion of dollars of revenue into the ability to handle debt expense over a relevant time frame becomes the critical determinant. Of equal importance, are what each company’s financial priorities are and whether they will be able to meet them. So, if I haven’t put you to sleep by now, let me briefly further explain.

The first company I looked at was VZ, it was very hard to come to grips with what its large debt load meant to its future. The good news was that its long-term debt appeared to have deceased from 143B to 133B from 3^rd Q 21 to 3^rd Q 22 (VZ 3rd Qtr 10Q). The bad news is that it was still a big number. So, I peeled the next layer back. The majority of VZ’s debt has a maturity greater than 10 years. As revealed in VZ’s last annual report (VZ 2021 Annual Report), over 90% of its debt is at fixed rates and most of those rates would be considered attractive, especially considering today’s environment. VZ occasionally buys back some of its debt in the open market and it has a sizeable Green Bond. Its pension assets just about equal its pension obligations ($20.1B and $20.2B), its interest coverage is 7.1X, and it owns the majority of its infrastructure. Its dividend coverage is right around 49% (Source Valueline).

The priorities for VZ’s cash flow were clearly stated by their CEO at the recent UBS Global TMT Conference: “When it comes down to usage of it, number one is in the network…. number two is continue to see that our shareholders or our Board is in a position to continue doing good dividend payments…and finally we are going to pay down debt…. ultimately, when we are done paying down debt to a level, which we think is reasonable, we are going to buy back shares.”

T’s financial position after the dividend cut, is similar to VZ, though not quite as solid. It pays out a little less of its profits in dividends, its interest coverage is 5.4x, and its pension assets have more distance from its pension obligations ($54.4B to $57.6B) (Source Valueline). It has significantly more debt due in five years. Still, it has a good cash flow and its priorities for cash appear to be roughly in line with VZ’s at this point.

TMUS is a very different animal. It is not a dividend paying stock and its pension assets and obligations are a minuscule part of its capital structure. While debt is not as often mentioned as an issue with TMUS as it is with VZ and, more especially, T, it has a higher proportion of it due in five years than either (over a third). It has lower total interest coverage of 3.5x, though that figure is looking up (Source Valueline). What it has announced is a significant stock buyback program with purchases “up to” 60B through 2025. There is some significant skepticism around this high of a number as it would probably exceed its free cash flow during this period. Another significant feature of the TMUS capital structure is how much of its stock is owned by Deutsche Telekom. It was Deutsche Telekom that merged its T-Mobile USA unit with MetroPCS in 2013, creating TMUS. Deutsche Telekom has shown a propensity to increase its stake in TMUS and now owns at 48% (Source Morningstar). This relationship has undoubtedly been beneficial as long as TMUS is the best use of Deutsche Telekom’s capital. It does bear watching should conditions change.

TMUS does hold a massive amount of useful spectrum, which should serve its needs out into the future. Much of this today is fallow. However, it does lease rather than own some of this spectrum and later in this decade Morningstar estimates that the costs to acquire the licenses in the 2.5GHz mid-band that are currently leased have a present value of about $10B. This seems like a good trade-off compared to the huge amounts that T and VZ have paid for spectrum in recent auctions. Of more significance, TMUS does not own its fixed line infrastructure. As the network becomes denser and the need for end-to-end engineering optimization becomes more acute and/or leases become more expensive, TMUS may want to acquire a fixed lined infrastructure closer to what T and VZ already own.

How Much and What Type of Spectrum is Enough?

The answer is that it depends on your strategy. Spectrum is a scarce and expensive resource. What telcos are advertising as 5G operates in low, mid, and high frequency bands. What seems to be more of a constant among them is a more efficient coding scheme, orthogonal frequency-division multiplexing.

With regard to the spectrum itself, the lower the frequency band the broader the coverage but with more latency and less speed. The higher the frequency bands, the higher the speeds and lower the latency. But there are tradeoffs as higher frequency bands are more subject to interference, less likely to penetrate walls and foliage, provide less coverage per cell, and will therefore require denser cell sites to provide adequate signal.

Mid band spectrum, C-band, is considered the sweet spot for coverage and capacity, which is why the results of the FCC’s auction 107, announced in early 2021, are often mentioned. The results of this auction were widely reported in the press at the time. These results will have a decisive impact on the future of the telcos over the next decade. Verizon and AT&T spent big in this auction. Verizon’s total spend was $45.4B and AT&T’s $23.4. T-Mobile spent $9.3B but as mentioned above, it already had very considerable spectrum assets from its acquisition of Sprint.

Of just about equal importance, though several large cable companies bid, they won none. This freezes them out of the direct race to 5G as major competitors to the three large telcos. But the bottom line is how much you hold of what type, where you hold it, how fast you can deploy it, and what the ultimate market is for the various versions of 5G has to be taken into consideration. It is not just total holdings. You can expect the telcos to use low, mid, and high frequency depending on the use case and availability. Let the spectrum suit the strategy and market appetite is the key.

Where to Next?

At the UBS 2022 Global TMT Conference, held the first week in December 2022, senior representatives of VZ, T and TMUS were all interviewed by John Hodulik, an extremely knowledgeable analyst. VZ was represented by Hans Vestberg, Chairman and CEO of VZ. T was represented by John McElfresh, COO at T. And TMUS was represented by Mike Sievert, President and CEO of TMUS. There was a wealth of future strategy information provided, which I will attempt to summarize and compare. First by looking at what they all had in common and then by highlighting the differences. (All subsequent quotes in the comparisons came from each companies’ representative in the three presentations. They have only occasionally been slightly edited for readability).

Similarities in Strategy

In the mobile consumer space, VZ, TMUS, and T are the major players and almost at parity. VZ holds about 40% of the subscribers, and basically TMUS and T split the rest. They all operate at significant scale, a scale at which spreading fixed costs in a capital-intensive business becomes very important. They have all spent significant sums in the last few years to position themselves for the 5G race, primarily in mid-band: TMUS with the Sprint acquisition, and VZ and T acquiring large amounts of spectrum in the recent auction. And all three are trying to work out their relationships with cable companies, DISH, and other providers and wholesalers.

VZ, TMUS and T are all committed to leveling out or reducing their recent CAPEX upswings, though one has to give a special mention to TMUS for what appears to be excellent progress and rationalization of infrastructure as they integrate Sprint into the TMUS network and the service and retail store structure. They all can boost subscriber rates through the stacking of promos and accepting lower margins. Price increases, of course, tend to have the opposite effect. This is why one should view askance less than persistent changes in subscriber numbers.

Differences in Strategy

How the three telcos view their customer base and how they market their products is very important to how one decides where to park one’s future investment dollars or if to park any in this space. Let’s take VZ, TMUS and T, one at a time.

VZ very much sees their consumer customers in a vertical stack from entry level in the prepaid market to those willing to pay for a premium product. As the VZ CEO explained at the UBS Conference, this is why VZ bought TracFone even though “we don’t have the technology in between TracFone and the Verizon brand because we are in the middle of an integration.” Over time they see a step up from the prepaid or the value segment to the premium segment. At this same conference the VZ CEO stated VZ is not committed to a general price reduction—“So again, very much being surgical in different segments rather than being a blanket over everything, either with price increases or reductions.” The second thing that is quite obvious is that, while they don’t dismiss the consumer fiber they have, their new investment is going into fixed wireless access and growth in urban and suburban areas, not rural. They have fiber in eight major markets and it appears that is where the investment in it stops.

VZ offers fixed wireless at three tier speeds initially. By 2025, their target is 50 million households covered with fixed wireless, with four to five million actually buying it. VZ also wants to position themselves to provide the same customer both broadband and mobility as they see that as one way to lower churn. They see getting customers initially on fixed wireless as a way to get to that goal. And they see an advantage in having one network that can be engineered end to end. With business they see things evolving in a flexible way with an emerging interest in 5G private networks. As the VZ CEO summed it up at the UBS Conference, “The mobility in consumer mobility business, fixed wireless access together with FIOS in national broadband and then the sort of private 5G networks. Those are the engines that we have…. they’re all built on the same seamless network from the Verizon Intelligent network, from the data center to the access is one seamless network with fiber in between, all the routers and everything.”

TMUS is building a lot on its reputation as being the best mobile pure play company with the best assets and its agility and ability to look around corners. As the TMUS CEO stated at the UBS conference, “This company understood that 5G would unfold and mid-band.” But probably TMUS’s best theme at the conference was investing in their customers— “if you love and invest in customers around things like vanishing contracts, or getting rid of hidden fees or buying out their contracts at other companies so they can have freedom, or giving them global roaming free, including with their plan, or things like getting rid of data plans altogether and going unlimited… We don’t do price increases.” In short, one is making a not unfounded bet on the most successful and customer-oriented management.

TMUS is the leading mobile provider in many of the top markets today and plan to turn that same approach to smaller markets. The TMUS CEO at the UBS Conference did not mince words about what TMUS was targeting— “things like tackling smaller markets in rural areas where our market share is in the teens. And enterprises, where our market share is just breaking into the double-digits, where 90% of customers are with AT&T and Verizon.” They have a strategy to convince people that they can have the best network and the best value and to convince people they do not have to make a trade-off to get both. So TMUS does not want a new strategy per se but to execute on the strategy that has made them successful in a broader market.

And, as stated at the UBS Conference, even in the markets where TMUS has a dominant position they are still “going after the tens of millions of people who never gave us a good luck when we were a come from behind on network.”

So, one is going to see T-Mobile stores and marketing in places they did not exist before and incentives and strategies that make it easier for people to switch—launched “Easy Switch” last summer. They will stick with an asset light approach to capital expenditures. With regard to business customers, they want to get in the door on price and then, as their CEO stated at the UBS conference, “use our 5G leadership and our leadership in standalone capabilities, private networks, and mobile edge compute to win that corner office relationship.” Do not look for TMUS to get into the broadband market with fixed wireless access or fiber anytime soon. Look for them to stick with mobility and to defend share and take share where they can.

T is in some ways similar but in some important areas very different than either TMUS or VZ. Similar in that its device promotion to not just new customers but existing customers was a hit—they picked up on theme of investing in their customers and creating loyalty and lower churn. And they have also found ways to tailor their products to a very specific subset of customers such as FirstNet, with first responders. FirstNet has features such as push to talk, interoperability with land mobile radios, ability to locate someone on a vertical axis, and enhanced visual location tools. This was some non-trivial engineering.

Unlike VZ or TMUS, T is making a substantial commitment to fiber broadband access. While T is not opposed to fixed wireless access and will implement it particularly for their business customers, their focus is on 5G mobility and fiber. As T’s COO explained at the UBS Conference, “At AT&T, I mean, we’ve been very disciplined and very clear on this. Our lead offer and our priority is 5G and fiber.” T likes fiber because it believes it can support much higher and increasing levels of bandwidth through it at a lower cost over a longer time, bandwidth that the customer will want and that eventually wireless cannot serve and still be profitable. T is pressing on with their plan to build out 30 million homes with fiber by 2025 and is today in roughly 10,000 neighborhoods laying fiber. Important from an investing standpoint, T has interim goals that progress can be measured against. So, the T mobility piece is moving similar to VZ and TMUS, but its broadband approach is different.

Valuation Always Matters

One of my favorite Warren Buffet quotes is “Price is what you pay, value is what you get.” And there are some big differences among the telcos worth examining on this point. And it is also worthwhile making some future excursions (Source data in table from Yahoo Finance and Valueline).

Comparison of Price, Yield, and PE (12/19/2022)
Company	Price	Div Yield	PE	2017 to 2021 Annual Avg PE
AT&T	18.03	6.00	7.45	10.1
VZ	37.24	7.03	8.10	11.6
TMUS	142.88	nil	21.3	27.26

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What sticks out here, is that T and VZ have been bought as value stocks with high dividends but with low to non-existent price appreciation. TMUS has been treated as a growth stock, and rightfully so. What I asked first was what would happen if T and VZ were to return to their average annual PE. Obviously, there would be some significant price appreciation as long as earnings did not decrease. And, recession aside, I see no reason to project sustained lower than present earnings at this time and possibly very small increases. TMUS bears a little more examination. TMUS in 2019 had a high stock price of $83.90. However, with the acquisition of Sprint and its resulting improved prospects, its stock price jumped significantly but with a lot of space between its annual high and low. It was not until 2022 that its earnings caught up with its prospects and they did so in a grand way (Source data from Valueline).

T-MOBILE RECENT HISTORY OF PRICE and EARNINGS
YEAR	2020	2021	2022
HIGH PRICE	$135.00	$150.20	$154.40
LOW PRICE	$63.5	$106.70	$101.50
EARNINGS	3.66	$3.17	E$6.70

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The big thing that jumps out here is the doubling of earnings in 2022, the gap between high and low stock prices each year, and the relatively stable high stock price each year. What I took away from this is that the benefits of the Sprint integration kicked in big time this year but had been priced in for several years preceding. It also is clear that when an investor bought the stock during a year is making a big difference to the price return, which is its only return.

Confessions, Caveats, and Conclusions

If you have stuck with me this far, by now you realize that I do not view the trade space among these stocks as a simple one. Whether one buys any of the telcos at this point depends a great deal on how one views their present situation as well as the future demand and evolution of their products. Bandwidth is becoming more of a commodity no matter how it is delivered—oh brave new world that has such creatures in it. And in the case of T and VZ, one’s decisions might depend on whether one believes fiber or wireless fixed access will prevail and how cable companies might rise to meet the challenge of both firms.

My own leanings are towards fiber to the residence or business enterprise with a WiFi and an edge computing interior landscape on the customer side of the fence. Though I am not technically qualified to debate this extensively, the one thing I am relatively sure of is that applications and use cases will evolve to use the bandwidth available, if it is reasonably priced. And customers now know better about what they want and need to include wanting more control. Fiber has a proven ability to provide lots of bandwidth without some of the technical risk of the new technologies embedded in fixed wireless access. I also like T because it seems to have learned something from TMUS about how to treat its customers and am not enamored of the upsell strategy of VZ, even though VZ is now what I own.

I see both T and VZ as somewhat undervalued at this point with the clear potential to rise to their historical levels of valuation, with the dividend providing some floor to further deterioration. If forced to choose one, I would buy T on both its near- and longer-term potential, as long as its management does not go bonkers again. So, any additions now on will be to T. TMUS is a great company that will, I believe, execute its strategy very successfully. And it has a proven track record of being able to do that. However, at its present price and valuation, I think it is a hold. When it does its annual volatility thing and its PE drops into the 15 to 18 range, I would buy it. That is still considerably above the valuation of T and VZ; but right now, it is too far above. I do not see another acquisition of the benefit that Sprint had in the near term and I do not know what Deutsche Telekom might do with its shares. Nor do I see T and VZ as asleep at the switch as they have been. They now have the C-band assets to compete. It is going to be very hard for TMUS to increase and perhaps to hold share in the major markets for mobile. Its strategy in rural markets will bear fruit.

So, there you have it. Look forward to reading your comments.