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.
When Wilfred Frost interviewed me on CNBC a year ago on 12/31/2019 for my top picks for 2020, I chose: AMD, DIS, FB, LITE, and NVDA. Below is how they have performed year-to-date through 12/28/20:
Top Picks for 2020 had a technology bias
However unlike my top picks for 2020, my top picks for 2021 have a value reopening bias. My picks are the following: JPM, XLE, MGA, ORCL, and GAN.
The S&P500 is up 16% YTD (12/28/20) and at an all-time record highs despite Covid-19 driven by both monetary and fiscal stimulus.
However, inflation has been relatively non-existent since the Global Financial Crisis (arguably for 40 years) and is worth watching in 2021. Right now, broad measures of inflation look contained and any concerns about inflation due to the easy money policies following the global financial crisis have been wrong. In fact 10 year treasury yields have been in a bull market for nearly 40 years since peaking at 16% in 1981 and currently are at 0.9%.
Rising Commodity Prices
We find it troubling that prices for industrial metals like copper, nickel and zinc are all up over 20% YTD during a global recession and agricultural commodities such as corn and wheat are up almost 10% YTD. And this is reflected in the price of gold that is up over 20% and bitcoin up over 250%. Even high-priced items like used US cars are up 17% y/y in November and US home prices are up 7%. There has been underinvestment in agricultural, mining and oil for the last decade which has helped drive price increases during a global recession. What might commodity prices do in late 2022 when demand improves after we have had mass vaccinations and global economies are fully re-opened? 10-year treasury yields started the year at 1.9% hit a low of 0.5% and are still only at 0.9%. US GDP is forecast to be up over 5% in 2021 which will be the best growth since 1984.
Potential Rising Interest Rates
It is not a stretch to think 10 year treasury yields could head back towards the 2% level prior to Covid by late 2021 from roughly 0.9% today as global economies reopen. The question is what this does to the record high S&P500 multiple and especially long duration assets such as growth stocks.
Potential Reduction in Pace of Future Stimulus
Stimulus has been incredibly important during this last decade for markets and if it is more subdued as economies get back to normal, this could be an issue as we have seen in the past. In 2011, 2015, 2018, and 2020, the stock market fell 10-20% over 1- 5 months during periods when monetary stimulus was flat to down.
Investment Themes 2021
JPM- banking for higher rates in 2021 as economies reopen
As we look toward 2021, we have more of a value bent to our investments and banks could be the ultimate reopening trade in 2021. The sector should benefit from stronger loan growth from an improving economy in tandem with expanding profit margins, yield curve steepening, reserve releases and share buybacks. This has been the second worst performing sector in the S&P in 2020 (down 5% YTD) and we believe it could be one of the best in 2021.
The S&P financial sector has a CY21 PE of 11x and a dividend yield of 2.1% and is down 5% YTD versus the S&P up 16% YTD, a 22x PE and dividend yield of 1.6%. At one point, this sector had the worst performance relative to the S&P in the history of the data back to the mid-1980s, which includes the global financial crisis and the tech bubble meltdown. We believe EPS growth for the sector could approach 20% in both 2021 and 2022.
In the banking sector, JPM (13x CY21 PE) is our core investment benefitting from a stronger economy driving loan growth and rising treasury yields. We also own Wells Fargo (-44% YTD) as a higher risk/higher reward way to play this theme as well as some smaller regional banks.
XLE- energy for improved demand as economies reopen
The energy sector has been the worst S&P sector (-37% YTD) by far this year but reopening economies will lead to an improvement in oil demand in 2021. We like the energy ETF (XLE) as a diversified way for investors to play this theme where many companies have high leverage/risk. We own a basket of individual names in the sector. Also with the focus on Green energy, the energy sector is hated and therefore valuations are low.
Tech Sector Picks
In the technology sector, we recently added more value oriented names to the portfolio to play our favorite themes such MGA (12x CY21PE) for Electric Vehicles, Oracle for cloud (14x CY21 PE) and GAN (8x EV/Sales) for online gambling.
ORCL – a value play in cloud software
Oracle has had no real revenue growth over the past 3 years with only 2% revenue growth in their most recent November quarter while the software sector has been one of the hottest areas within technology. We think that in 2021, Oracle may finally see revenue growth starting to pick up driven by their Oracle Cloud Infrastructure (OCI) business which grew 139% y/y and their autonomous database business which grew 64%. OCI growth could have been even better if not for capacity constraints. Both businesses combined are $1.5B in revs (4% of total) but are growing at ~100% and should matter to rev growth next year. Given Oracle trades at only 14x CY21 PE relative to the S&P at 22x, any improvement in their growth rate is likely to help their stock price tremendously. Oracle is also very shareholder friendly and has cut their share count by 40% through buybacks over the past 10 years.
MGA- a value play for Electric Vehicle adoption
Unit sales has improved for the auto industry from down 48% y/y in April to down 5% in November. Low interest rates, low inventories, more driving, less flying, has driven auto sales. The focus on green energy has helped drive EV sales as witnessed by the addition of Tesla to the S&P500. But EV industry shipments are only 3% of the total with a lot of growth ahead. MGA already has relationships with Fisker, Waymo (Google) as well as automakers in China and Korea around EV vehicles. MGA a few years ago was reportedly in discussions with Apple on helping them produce EV vehicles. Magna’s JV with LG Electronics announced last week helps round out the components they did not possess. At only a 12x PE, MGA is a cheap way to play the EV trend.
GAN- a value play as Online Gambling becomes the next big internet market (Replaced by $BETZ on 1/19/21 here)
Online sports betting is the next massive internet market driven by state legalization following the Supreme Court legalizing online sports betting in May of 2018. The total Global Gaming market is roughly $450B and growing ~10% per year w/ only 12% on-line. GAN, with their acquisition of CoolBets, now has an online sports betting offering to complement their iGaming products. We believe the multiple will rerate as more states use GAN partners, such as FanDuel, who will be using their technology. The stock only trades at 8x CY21 EV/Sales versus some comparable companies that are over 20x.
Dan Niles is founder and portfolio manager for the Satori Fund, a tech-focused hedge fund.