AT&T Yahoo/Verizon accounts? Analysis of AT&T’s Business & Earnings, by David Dixon of FBR Group
What will AT&T do about it’s AT&T-Yahoo accounts (including email) now that Yahoo Internet Portal has been sold to Verizon? AT&T-Yahoo email has been deteriorating for months. Will AT&T now offer AT&T-Verizon email accounts?
Growing International Focus Bears Fruit, but Ongoing Domestic Weakness Is a Concern, David Dixon of FBR
AT&T reported largely in-line 2Q16 financial results and mixed subscriber results. Its focus on growing the newly acquired Mexican operations appeared to bear fruit, helping offset ongoing U.S. weakness. AT&T added 742,000 wireless net subscribers in Mexico in the quarter, and total Mexican wireless subscribers now approach 10M.
AT&T’s Mexican LTE deployment now serves 65M PoPs and is expected to reach 75M by year-end. While the LatAm macroeconomic environment is expected to remain challenging, we expect the upcoming Rio Olympics to build on recent subscriber momentum. In the U.S., total 2Q net adds of 1.36M were meaningfully below consensus of 1.78M. Management attributed net add weakness to the planned shutdown of the 2G network and a network outage caused by an equipment vendor. We believe the domestic net add weakness is more likely a result of shifting focus on profitability rather than subscriber count. With the LTE network buildout complete and AT&T diversifying into Mexico to alleviate churn pressures, further changes to smart phone upgrade eligibility are likely.
We think AT&T is challenged by T-Mobile USA (TMUS) for the low-end customer and is focused on maintaining share of the more profitable enterprise market as well as improving ARPU in the interim, ahead of TMUS facing capacity challenges in the coming one to two years, based on our vendor checks.
■ 2Q16 results recap: Including DIRECTV results, consolidated revenues increased 22.7% YOY to $40.5B, modestly below consensus’ estimate of $40.6B and higher than our estimate of $40.0B. By segment: business solutions delivered revenues of $17.6B, entertainment and Internet services had revenues of $12.7B, consumer mobility had revenues of $8.2B, and international had revenues of $1.8B.
Adjusted EBITDA of $13.4B were just shy of our Streetcomparable estimate of $13.6B. EBITDA margins declined 30 bps YOY to 33.0%. Consumer mobility postpaid net adds were 72,000, prepaid net adds were 365,000, and postpaid churn was 1.09%.
■ Further expansion of GigaPower: GigaPower now reaches 2.2M homes and is expected to increase to 2.6M or more by year-end. We believe AT&T’s fiber investment is a negative NPV decision but necessary to continue over many years until it equates to cable because a decision not to invest would drive a more negative NPV outcome due to the superior competitive positioning from the cable sector. Combined with a shift toward software-defined network (SDN), the expanded fiber footprint afforded by GigaPower should benefit T as the Internet of Things (IoT) becomes more prevalent and as 5G is deployed. We believe AT&T is the market leader in the burgeoning IoT segment, which was largely standardized this year and should underpin faster growth rates.
■ FY16 guidance maintained. Management reiterated prior issued guidance of double-digit consolidated revenue growth, adjusted EPS growth of mid single digits or better, stable consolidated margins, and $22.0B in capex.
■ We believe AT&T will benefit from the Olympics through cross-selling DIRECTV products in Latin America, partially offset by continued competition in the U.S. carrier market.
1. Can AT&T drive earnings growth? 6 to 18 months
Smartphone activations remain significant. Strategic initiatives with Samsung and Google, coupled with support of the Windows Phone ecosystem by MSFT, NOK, and other OEMs, are key to lower wireless subsidy pressure, but it is early days. We think AT&T will continue to consider pricing action to augment growth once the LTE network build is complete, but competitive intensity is likely to increase in FY16, so this will prove difficult absent consolidation or until T-Mobile US becomes spectrum challenged, which we think is still one year away and a function of T-Mobile US commitment to continue network investment.
2. How will AT&T fare in the changing wireless landscape in 2016 and beyond?
Our strategic concerns for AT&T include (1) the Apple eSIM impact, should Apple be successful in striking wholesale agreements; (2) the Google MVNO impact, which could strip the company of the last bastion of connectivity revenue; and (3) a Wi-Fi first network from Comcast, coupled with a wholesale agreement with a carrier, which would enable a competitor and increase pricing pressure
3. Does AT&T have a sustainable spectrum advantage compared with other carriers?
AT&T is behind Verizon in spectrum and out of spectrum in numerous major markets, according to our vendor checks. However, with additional density investment, it is reasonably well positioned to benefit from the combination of coverage layer (700 MHz and 850 MHz) and capacity layer (1,700 MHz, 1,900 MHz, and soon-to-be-confirmed 2,300 MHz) spectrum and will focus on LTE and LTE Advanced, as well as refarming 850 MHz/1,900 MHz spectrum for additional coverage and capacity. Yet this nonstandard LTE band will cost more capex and take longer to implement. In the short run, aggressive cell splitting is expected, and metro Wi-Fi and small-cell solutions with economic backhaul solutions are becoming available, allowing for greater surgical reuse of existing spectrum. Sprint s differentiation through Clearwire spectrum in FY16 is only likely to modestly affect AT&T relative to Verizon. Furthermore, with 70% 80% of wireless data traffic on Wi-Fi and only 20% of capacity utilized, this suggests a focus in this area to manage data usage growth.
We expect the wireless segment to continue to be challenged by a resurgent T-Mobile USA. We are less bullish on near-term improvements in capex intensity, due to cultural challenges associated with the much-needed migration to software-centric networks, coupled with the need to upgrade its fiber plant aggressively to improve its competitive positioning and lay the foundation for efficiency improvement.