I try to pay attention to most asked questions on my twitter and website. Many of you seem to have questions on AT&T and so I wanted to do this quick write up for you.
I am sticking to my long in AT&T despite negative developments over the past 3 weeks but am willing to move on if things do not improve.
AT&T’s acquisition of DTV in 2015 is why this name has one of our favorite short idea off and on over the past five years. AT&T has been a melting ice cube ever since their acquisition of DTV in 2015. They bought this business for $48.5 billion in 2015 and $64B including debt. During their recent attempts to sell all or part of it, the bids were coming in around ~$15B including debt. What an incredible destruction of value during that time. In addition, the company borrowed heavily to do the deal.
My fundamental view has been for quite some time that consumers will continue to cut their satellite/cable TV services in favor of streaming services. In 2015, there were roughly 100M US households with a PayTV service such as satellite or cable. That number is estimated to drop to just over 80M in 2020. During this time, Netflix has gone from 80M global subscribers at the end of 2015 to 195M in Q3:20 with 73M in the US/Canada. It is estimated that close to one-quarter of US households do not have a pay TV service today. Cord cutting combined with AT&T’s debt level is the core reason I have been primarily short AT&T off and on over this period of time.
AT&T’s high debt level is important because it affects their ability to support their dividend. As of Q3, AT&T’s debt to EBITDA was 2.7x. However, after adjusting this like the ratings agencies do for items such as operating leases, pension obligations and post-retirement benefits, it is closer to 3.5x EBITDA.
AT&T in fact did not increase their dividend for the first time since 2005 this year which speaks to their current issues. AT&T’s dividend yield currently is at 7.3% Verizon 4.3%, the S&P 1.6% and ten-year treasury yields 0.9%. These differences are near record levels given investor concerns over the melting DTV subscribers and high debt levels.
However, if HBO Max can ramp enough, this could help AT&T’s multiple expand from 9x CY21 PE versus the S&P at 22x and Verizon at 12x. These valuation discrepancies are also near record levels. AT&T’s streaming service, HBO Max, launched on May 27th, 2020. On December 8th, AT&T’s CEO John Stankey spoke at an investments conference and had some encouraging updates. He announced HBO Max engagement was up 36% in the last 30 days and they had reached 12.6M activated subscribers which was up 4M from the end of Q3. We believe this growth should accelerate given that Wonder Woman 84 streamed and opened at theatres simultaneously on Christmas Day. In addition, all seventeen Warner Bros. movies in 2021 are slated to do the same. There were 28.7M paying customers that had access to HBO Max at the end of Q3 and we think many of them will activate their service.
The recent weakness in the stock has been driven by multiple factors but primarily by a spectrum auction which started on December 8th that already has been ~50% more expensive than expected. The 280Mhz spectrum being auctioned off is considered prime real estate for 5G. As a result, the bids have now reached $70B which is well above the 2015 AWS-3 auction record of $45B. Assuming current assumptions of AT&T spending about one-quarter of the ultimate total is correct (with Verizon closer to 45%) this implies at least an extra $6B of spend beyond what was expected in early December. One way we have tried to hedge part of this risk is by shorting Verizon which needs much more spectrum than AT&T. Since the auction started on December 8th, AT&T is down 6.7% while Verizon is down 4.4% and the S&P is up 1.5%.
Lack of progress selling a stake in DTV has been the second big problem. As we stated earlier, our main reason for disliking AT&T for several years was their ownership of DirecTV given the pressure from cord cutting/streaming. AT&T had been trying to sell a portion of the DirecTV business so they could deconsolidate this business from AT&T’s books but that seems to have been put on hold due to the low bids received of $15B at the high end.
And finally, Wonder Woman 84 and disclosed HBO Max streaming data has not been as detailed as we would have hoped. According to AT&T, Wonder Woman 1984 was viewed by nearly half of the streamer's subscribers on the film's launch date alone. The Niles household was one of them. In addition, it was watched by viewers on services by their partners which was in the millions also. But we do not know how many total subscribers are now on the platform which is really what is important for the stock’s multiple. The stock also did not budge when this data came out.
Cheap stocks can always get cheaper and market reaction to news must be respected. One of the greatest mistakes an investor can make is getting wed to a position and not admitting they made a mistake. At the end of the day, it does not matter what you believe a stock should be valued at but what everyone collectively believes a stock should be valued at. In Disney’s case, they are now considered a winner in the streaming wars. As a result, their PE has expanded from the mid-teens prior to the mid-30s PE on normalized earnings post Covid-19. Disney’s stock is up 25% this year despite revenues being estimated down 20% while AT&T’s stock is down 26% despite revenues only being estimated down 6%. This is despite Disney not paying its usual semi-annual dividend in July or in January 2021.
For the factors cited above (auction expense, stalled sale of DTV, lack of HBO Max data around Wonder Woman release) there is a reason we did not pick AT&T as one of our top 5 picks for 2020. Those top picks are stocks that we hope investors can just buy and hold in an economy that should see the fastest GDP growth since 1984. AT&T, however, requires a restructuring of the company and the way investors view the company. As a result, this requires more active management of the position which remains our largest long position for now. But if investors remain more focused on the expensive C-band auction and lack of progress getting DTV deconsolidated than the momentum in HBO Max, the stock is likely to languish. We will have to admit our mistake and move on.
I hope this was helpful and I wish everyone a Happy 2021.
Dan Niles is founder and portfolio manager for the Satori Fund, a tech-focused hedge fund.