AT&T Stays Ahead of the Curve in a Dynamic Industry

In this era, where 80% of Americans now own a cell phone, the days before cell phones were our constant connection to the outside world are a memory growing more distant every day. Increasingly, professionals view mobile devices as an indispensable tool and individuals crave connectivity to the internet for email, gaming, and browsing. Telecommunication companies are hopping on the bandwagon, trying to feed the growing need for connectivity by expanding the rolls that can be filled by cell phones. Consumers clamor for the expanded capabilities of what could be described as mobile computers that feature a phone.

AT&T (T) released its second quarter numbers early Wednesday morning, and EPS results were in line with estimates at 76 cents per share, excluding merger charges. A closer look at the numbers underscores the importance of the shifting dynamics of the industry and AT&T’s efforts to stay ahead of the curve are coming to fruition. 

The wireless unit was the highlight of the quarter for AT&T. Earnings surged 91% while revenue increased 16%. When taking away charges related to its merger with BellSouth, profits rose by 39%. One key to this success is the huge growth in data plan usage as revenue derived from data plans rose 52%. AT&T loves to sell the profitable data plans, which have helped to boost average revenue per user by a very respectable 3.5%. Furthermore, AT&T grew its subscriber base by 1.3 million, as it has attracted Applephiles away from competitors with its exclusive offering of the iPhone.  Also, AT&T’s churn rate—the rate at which it is losing subscribers—has slowed from 1.2% to 1.1%.

The impressive strides made by the wireless unit contrasts with the wire line business, which continues to lose ground. Earnings were down slightly at 2.4% as revenues slipped by 2.1%, which was actually more muted than losses in previous quarters. This is further demonstration that Americans view landlines as increasingly obsolete. Surely, businesses will continue to need landline telephones but the cell phone is well on its way to replacing the home phone.

AT&T also has a unique asset that no other carrier does, the Apple (AAPL) iPhone. AT&T’s exclusive right to carry the iPhone has certainly been a huge draw for new subscribers. Demand for iPhones has been quite strong, and it has been widely publicized that Apple sold 1 million iPhones in the first 3 days. In order to buy the 3G iPhone, consumers are signing up for 2 year AT&T contracts. However, much of the earnings gains from new subscribers will be deferred over the life of the contract. The subsidy that AT&T pays Apple to make the iPhone more affordable could hurt earnings in the short run; some analysts have estimated a hit of $.10- $.12 per share. We view the iPhone as having a huge potential upside and–from the perspective of a long-term investor–the short-term earnings compression is worth the long-term subscriber gains.

We have AT&T rated a Strong Buy right now because its valuation is quite compelling. AT&T historically trades in a range from 1.95 - 2.81 times revenues, but the stock is currently trading at only 1.54 times current revenue. Likewise, price-to-cash earnings historically range between 6.5x and 9.3x, but this valuation measure is currently only 4.8 times. With the sort of momentum that AT&T is generating with the iPhone in combination with Blackberries and the stock trading near 52 week lows, the value that AT&T represents will not go unnoticed for long.