Tuesday, March 22, 2011

ATT & T Mobile

This week's announcement of ATT's proposal to buy T Mobile's US network received copious amounts of coverage in the business press.

My first inclination, to be blunt, was to check on the equity price moves of the major US telecoms for the past five years, and more.

It isn't pretty.

The first chart displays ATT, Verizon, Sprint and the S&P500 Index for the past five years. Sprint is clearly the big loser, but the other two could only manage to match the Index.

Think about that. In such a capital intensive, advanced technological business, Verizon and ATT can, at best, only manage to give you the equity market index return, with no premium for the risk of lack of diversification.

The next chart displays the long term price moves of the same series. Sprint, again, is the big loser. But the other two haven't even matched the S&P over the longer timeframe.


Before you get all amped up over this proposed deal, notice that the whole sector is an investment graveyard.

My hunch, born of my experiences with predecessor AT&T from 1979-82, was right. I can still recall, upon joining AT&T right out of graduate business school, seeing the single most riveting chart describing the company's situation. It was a Yankee Group chart showing the monotonically plunging free cash flow for AT&T. A trend that had begun a few years earlier, and was proceeding at breakneck speed. Everything about the business screamed 'value destruction,' in the classic Schumpeterian sense.

Existing prices and equipment were under attack. New products would provide incredible productivity increases for customers, while transitioning AT&T from the clunky, labor-intensive world of analog to the much more competitive, less-profitable digital world.

Everywhere I looked, I saw revenue forecasts failing to displace business lost to either competition or technology. People my age received a brutally quick introduction to deregulatory dynamics in telecommunications, airlines, and banking. It hasn't ceased yet.

Now, as to the strategies and tactics of the proposed deal.

T Mobile has the valued asset, with Sprint needing it  to remain relevant. So ATT promised a $3B breakup fee just to keep Sprint's hands off of T Mobile while the proposed merger is vetted by DOJ and God knows who else.

If ATT gets its prize, albeit at a P/E exceeding its own, it immediately increases its physical network assets and, perhaps most importantly, gets its target's valuable spectrum slots, while denying Sprint a viable means to remain competitive. If not, it's at least tied up T Mobile for a while, thus starving Sprint a little longer.

Why the putative architect of this deal, some investment banker from Chase, is so lauded is beyond me. I mean, with so few players, was this really something for which ATT and T Mobile needed a banker? Maybe for the basic funding mechanics, but nothing else.

As for the hoopla involving Chase underwriting the proposed deal with $20B of credit, so what? They're underwriting the purchase of infrastructure and spectrum, more than anything else. Not so risky. Given consumer behavior, even if the oligopolistic aspects of the deal allow some price increases, people are still going to continue to use their smart phones for data- and video-heavy apps, which will ensure the debt being paid off.

Meanwhile, according to CNBC's pundits and the Wall Street Journal, the regulatory issues are hardly trivial. For precisely that oligopoly effect of taking out one of four providers in the sector.

But, to me, win or lose, ATT's CEO, in an interview on CNBC Monday morning, said something that really gave me pause. Something right in line with this recent post.

Jenkins wrote about cloud computing, and smart phones certainly are a major contributor to the phenomenon. Stephens, ATT's CEO, noted that the firm needs more network capacity muy pronto, as even cars are now bringing apps traffic to cell phones. He mentioned some growth figure which, while I forget what it was, stunned me. After all, I, like many people, have already seen the commercial wherein a guy remotely accesses his car for his teen-aged daughter and her friend, then starts it via his cell phone app.

Far more than the old land-line engineers at the old Bell Labs and Long Lines, today's ATT network engineers must be terrified at the expected smart-phone and related device-based traffic coming their way on wireless networks. Meanwhile, nobody wants to pay much more for these conveniences.

Regardless of whether this deal is approved, or not, I doubt it will really make ATT a more attractive equity investment. Take another look at that second chart. None of the three telecom companies has a higher price today than ten years ago. It's just a lousy sector for investment, no matter how much more concentrated it gets. At least barring radical changes in regulatory-driven economics which allow a telco to become a reasonably pure play on market-based pricing for wireless bandwidth. Even then, however, the infrastructure requirements may dampen investor enthusiasm.

But, for now, I'd be surprised if this deal, if consummated, really does a whole lot for ATT's ability to earn consistently superior total returns in the years just ahead.

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