Network Investments Should Drive Steady Growth at AT&T

Director

Michael Hodel

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We believe AT&T's strategy to invest heavily in its networks makes sense and will serve investors well over the long term. Aggressively extending fiber and 5G coverage to more locations builds on its core assets—its existing network and customer relationships—and should allow AT&T to gradually expand its share of telecom spending. 

AT&T is the third-largest wireless carrier in the United States, but we believe it has adequate scale, spectrum, and financial resources relative to both Verizon and T-Mobile to generate solid profitability. Also, we believe the industry’s structure has improved in recent years, with three major players that have little incentive to price irrationally in search of short-term market share gains. We expect the industry will gradually reach competitive balance as each carrier deploys 5G technology on deep midband spectrum holdings and crafts pricing strategies that appeal to each market segment.

Upstart Dish Network could present challenges in some areas, but we don’t believe it presents a credible threat to the traditional wireless business. Also, AT&T and Dish have a wholesale relationship that should allow AT&T to participate in Dish's growth. We expect Dish will focus on emerging wireless applications in the enterprise market, an area where AT&T also has a strong presence.

AT&T also benefits from its ownership of deep network infrastructure across much of the U.S. and its ability to provide a range of telecom services. The firm plans to extend fiber to 30 million homes and businesses by the end of 2025, up from 22 million today, and has formed a joint venture with BlackRock to expand into new areas. These efforts should allow the company to serve these locations extremely well while also enhancing wireless coverage in the surrounding areas. If the firm hits its targets, it would be the third-largest high-quality fixed-line network in the U.S. (behind Comcast and Charter) and the only of the three to also own a nationwide wireless network. We expect AT&T will have the ability to use its combined wireless and fixed-line capabilities to grab market share in this large and growing territory over the next decade.

Business Strategy & Outlook

Wireless is AT&T's most important business. Returns on capital in wireless have eroded somewhat in recent years as the firm has spent heavily on wireless spectrum and invested to put that spectrum to use. We estimate the wireless business produced a return on capital in 2022 of roughly 8%, or about 10% excluding goodwill, modestly above our estimate of the firm’s cost of capital. These figures are down from about 10% and 12% in 2018. Over those four years, segment operating income is up 13% cumulatively while the invested capital base has expanded about 30%, primarily on $40 billion of spectrum purchases. 

We expect that wireless returns will remain ahead of AT&T’s cost of capital. Verizon, AT&T, and T-Mobile dominate the U.S. wireless market, collectively claiming nearly 90% of retail postpaid and prepaid phone customers between them and supplying the network capacity to support most other players. Providing solid nationwide coverage requires heavy fixed investments in wireless spectrum and network infrastructure. While a larger customer base does require incremental investment in network capacity, a significant portion of costs are either fixed or more efficiently absorbed as network utilization reaches optimal levels in more locations. 

The benefits of fixed-cost leverage and the difficulty of providing a differentiated wireless offering create an efficient scale advantage in the wireless industry. The massive consolidation across the industry over the past 15 years and the inability of several interested parties, including Dish Network and Comcast, to enter the market using their own networks provide evidence of efficient scale. Comcast relies on Verizon to support its wireless efforts while Dish will use both the AT&T and T-Mobile networks for several years as it attempts to build a nationwide network, more than a decade after it began assembling a spectrum portfolio. 

With three sizable players, we don’t expect the carriers will have an incentive to aggressively poach each other’s customers, given how painfully slow market share shifts occur in the business. We also expect the high cost of maintaining nationwide coverage and its diminutive size will limit Dish’s ability to compete on a large scale in the traditional wireless business over the long term. Each of the three major carriers has pledged substantial capital returns to shareholders: AT&T’s new dividend totals $8 billion annually and Verizon’s nearly $11 billion, while T-Mobile has said it can repurchase up to $60 billion of its shares through 2025. To support these returns, each of the carriers has guided investors to expect modest but steady revenue growth over the next several years. These actions indicate that none of the carriers is looking to radically disrupt the current pricing structure in the industry and that each will increase prices as needed to offset any cost pressures that emerge. 

Fixed-line enterprise services is AT&T’s next-largest segment. We believe this operation holds a solid competitive position in a consolidating market. AT&T is one of only a handful of companies capable of providing complex communications services to business customers with geographically diverse needs. We roughly estimate this segment earns 10%-15% returns on invested capital excluding goodwill (AT&T’s most recent major acquisition in this area was the 2005 purchase of the legacy AT&T long-distance business). Business services revenue has steadily declined in recent years, falling to less than $23 billion in 2022 from $29 billion five years earlier. Margins in this segment have held steady, but profits have also declined (EBITDA was less than $9 billion 2022 versus $11 billion in 2017). A significant but undisclosed amount of legacy business remains and will continue to exert pressure on growth over the next several years, but AT&T has begun to focus its efforts on core network connectivity and services where its assets allow it to deliver unique solutions. Management expects the segment will near stability in 2023 with growth returning thereafter. 

AT&T’s last significant business, consumer fixed-line services, doesn’t possess a moat, in our view. We estimate AT&T’s consumer fixed-line networks reach around 55 million homes, or a bit less than half of the U.S. population. This business is challenged competitively across most of this footprint thanks to inferior networks relative to cable competitors. About 25% of the homes in this service territory subscribe to AT&T’s internet access service, around half the penetration level Comcast claims. The gap between AT&T and its cable rivals has steadily widened over the past several years. Customer penetration is critical to driving profitability in the telecom business, and AT&T’s modest level has left returns on capital around 5%, by our estimate. 

AT&T has upgraded about one third of its residential footprint to a fiber-to-the-premises network, which provides a much stronger competitive position versus cable. The firm plans to expand the FTTP network aggressively over the next few years, but it has a long way to go on this effort. We expect price competition will remain rational as AT&T’s fiber network grows, as neither AT&T or the cable companies are likely to risk earning less revenue across their existing customer bases over the long term to gain share. 

The remainder of AT&T’s business includes the Mexican wireless business. We don’t believe the Mexican business has a moat, operating at a fraction of the scale of market leader America Movil. We wouldn’t be surprised if AT&T sold the Mexican wireless business in the near future.

Narrow

Economic Moat

AT&T

AT&T Mobility is a wholly owned subsidiary of AT&T that provides wireless services to 138.8 million subscribers in the United States including Puerto Rico and the U.S. Virgin Islands. AT&T Mobility is the second largest wireless telecommunications provider in the United States and Puerto Rico behind Verizon Wireless.

AT&T Mobility

The Pacific Bell Telephone Company (Pacific Bell) is a telephone company that provides telephone service in California. The company is owned by AT&T Inc. through AT&T Teleholdings. The company has been known by a number of names during which its service area has changed.

Pacific Bell

DirecTV (stylized as DIRECTV) is an American direct broadcast satellite service provider and is a subsidiary of AT&T. DirecTV transmits digital satellite television and audio to households in the United States, Latin America and the Caribbean. Its primary competitors are Dish Network and cable television providers. AT&T acquired DirecTV in a transaction valued at $67.1 billion.

Direct TV

Leap Wireless is a telecommunications operator that provided wireless services to approximately 4.6 million subscribers, the 5th largest, through its subsidiary, Cricket Communications, Inc. (Cricket Wireless). It was headquartered in San Diego, California. Leap Wireless and Cricket Wireless are both subsidiaries of AT&T.

Leap Wireless

Cricket Wireless is an American prepaid wireless service provider in the United States. Cricket Wireless is a wholly owned subsidiary of AT&T Inc. that offers mobile voice, text, and data. Cricket Wireless was founded in 1999 by Leap Wireless International, Inc. On July 12, 2013, AT&T Inc. agreed to acquire Cricket's parent company Leap Wireless International for $1.2 billion.

Cricket Wireless

Vyatta is a provider of software-based virtual routers, virtual firewalls and VPN products for Internet Protocol networks (IPv4 and IPv6). A free download of Vyatta has been available since March 2006. The system is a specialized Debian-based Linux distribution with networking applications such as Quagga, OpenVPN, and many others. A standardized management console, similar to Juniper JUNOS or Cisco IOS, in addition to a web-based GUI and traditional Linux system commands, provides configuration of the system and applications. In recent versions of Vyatta, web-based management interface is supplied only in the subscription edition. However, all functionality is available through KVM, serial console or SSH/telnet protocols. The software runs on standard x86-64 servers.

Vyatta

AT&T, Inc. is a holding company, which engages in the provision of telecommunications media and technology service. It operates through the Communications and Latin America segments. The Communications segment offers services to businesses and consumers located in the U.S., or in U.S. territories, and businesses globally. The Latin America segment is involved in entertainment and wireless services outside of the U.S. The company was founded in 1983 and is headquartered in Dallas, TX.

Earnings data Q2 2023

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