With M&A activity largely limited to pharma in 2014, AT&T’s (T) announcement to purchase DirecTV (DTV) is expanding the trend to new verticals for the year. While M&As often are rewarded with big spikes in stock prices, both stocks are down today with competitor Verizon (VZ) in the green.
Verizon has recently got the star treatment, despite being in a rather dull vertical. Both hedge funds and Warren Buffett have bet on the company, which has left talking heads chattering about what this means for the sector and the company. This has partly fed into T’s sell-off, as the acquisition for DirecTV is perceived as a desperate grab for new revenue streams amidst moribund expansion opportunities.
This may mean AT&T is a great buy opportunity—i.e., that the market has misunderstood the value of the company and its strategy—or it could simply mean the market has perceived a market share loser in a competitive and mature industry. Investors need to pick a side and bet accordingly.
There are many ways to do this, but the first step will always be to analyze each company’s revenue capture and operating margins as they have developed to the current time. Below is a basic chart for T, which should be the starting point for any discussion of the company:
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Here we see operating revenues have trended upwards at roughly 1% on average on a year-over-year basis, with the most recent quarter showing a sizable 3.5% year-over-year jump in revenues that drove the average significantly higher. Without that, revenues would be up less than half of 1% for the past year. This suggests AT&T’s ability to capture more revenue is being impacted by one of several possible factors (greater competition, market saturation, flat prices, or systemic deflationary pressures).
While the causes of T’s inability to grow revenues are important for deciding how to react to the stock, it’s a controversial topic that could be debated on end. What cannot be debated, however, is the company’s overall financial stability, which contributes to the bull case. Even as the company has found it unable to grow, it has had no problem maintaining a healthy operating margin of an average 18.34% over the past two years. That margin has not grown much, but it has been large enough to allow AT&T’s management plenty of room to return capital to shareholders.
Management has done that in a few ways. One is through share buybacks, which the company recently increased to amount to about $11 billion of returned capital to shareholders. Another is through dividends, which rose by a penny in 2014 just as they did every year since 2008.
Both strategies have made AT&T a reliable income provided. The stock has yielded a 7.7% CAGR from price appreciation over the past 5 years and another 6.2% from dividends. Not bad at all (and certainly enough to please any income-hungry retiree), but certainly not as good as the S&P 500—or, for that matter, competitors VZ, S, and TMUS.
Thus AT&T’s underperformance and its lack of favor from hedge funds is no surprise, and the company’s need to find new income streams and expansion opportunities is abundantly clear. Now the question investors need to answer is whether that acquisition is underappreciated despite its real value, or whether AT&T’s combination of stock buybacks and dividends are worth allocating assets for. These are not easy questions to answer, nor is there universal agreement in answering them.