Demand for wireless services continues to rise strongly. New phones and devices, such as Apple’s iPad and Amazon’s Kindle e-book reader, should continue to spur demand for wireless service. We still have a high opinion of Apple and Amazon. But their high share prices make them vulnerable to sudden setbacks.
We think network operators like AT&T and Verizon provide a conservative way to profit from the popularity of wireless devices. That’s because they have wider and steadier revenue sources than device makers.
AT&T INC. $26 (New York symbol T; Income Portfolio, Utilities sector; Shares outstanding: 5.9 billion; Market cap: $153.4 billion; Price-to-sales ratio: 1.3; Dividend yield: 6.5%; WSSF Rating: Average) gets 50% of its revenue by selling traditional telephone services to 45 million customers in 22 states. The company’s wireless division has 87 million customers nationwide, and accounts for 45% of AT&T’s revenue. The remaining 5% comes from selling ads in telephone directories.
AT&T took its present form in November 2005. That’s when SBC Communications Inc. bought the old AT&T Corp. for $16.3 billion. The combined company took the AT&T name.
Thanks to this purchase and strong demand for wireless services, AT&T’s revenue rose 182.8%, from $43.8 billion in 2005 to $124.0 billion in 2008. Its 2009 revenue fell 0.8%, to $123.0 billion, mainly because of weak sales of traditional phone services.
AT&T’s earnings rose 168.8%, from $4.8 billion in 2005 to $12.9 billion in 2008. Earnings per share rose 52.1%, from $1.42 in 2005 to $2.16 in 2008, on more shares outstanding. Earnings fell 1.9% in 2009, to $2.12 a share (or a total of $12.5 billion). Since 2007, AT&T has been the exclusive U.S. carrier of the hugely popular Apple iPhone.
The company added 2.7 million new iPhone subscribers in the first quarter of 2010. About a third of these clients are new to AT&T. That helped drive up its earnings by 12.9%, to $3.5 billion from $3.1 billion a year earlier. Per-share earnings rose 11.3%, to $0.59 from $0.53, on more shares outstanding.
The latest earnings exclude a $995-million, non-cash charge related to the recently passed U.S. healthcare bill. The new rules eliminate a subsidy that companies get when they contribute to their retired employees’ prescription-drug plans. The change does not take effect until 2013, but accounting rules force AT&T to recognize these costs immediately.
Revenue rose 0.3%, to $30.65 billion from $30.57 billion a year earlier. A 10.3% rise in wireless revenue helped offset a 12.0% revenue drop at AT&T’s traditional telephone operations.
AT&T set to lose iPhone exclusivity
AT&T will probably lose its exclusive right to the iPhone when its contract with Apple expires later this year. However, the company has been upgrading its wireless networks and adding new smartphones to its lineup. These moves should help it hang onto its current customers and add new ones as more consumers switch to wireless from traditional phones.
The company is also adding new services that are helping it offset lower traditional phone revenues and compete with cable companies. For example, its Uverse service transmits television signals through high-speed Internet networks. U-verse has 2.3 million customers, up 72.7% from a year ago.
AT&T’s long-term debt of $60.0 billion is a reasonable 40% of its market cap. That gives it plenty of room to keep improving its networks. It trades at just 11.6 times its likely 2010 earnings of $2.25 a share.
AT&T is a buy.
VERIZON COMMUNICATIONS INC. $29 (New York symbol VZ, Conservative Growth Portfolio, Utilities sector; Shares outstanding: 2.8 billion; Market cap: $81.2 billion; Price-to-sales ratio: 0.8; Dividend yield: 6.6%; WSSF Rating: Average) owns 55% of Verizon Wireless; U.K.-based Vodafone plc owns the other 45%. This business has 92.8 million customers in 50 U.S. states, and accounts for 60% of Verizon’s revenue. The remaining 40% comes from selling traditional telephone services to over 31.8 million customers in 25 states.
Like AT&T, Verizon’s expanding wireless business has cut its reliance on traditional phone services. As part of this expansion, Verizon Wireless bought wireless provider Alltel Corp. for $28.1 billion in January 2009 (Verizon’s share of the cost was $15.5 billion). As a result, Verizon’s revenue rose 55.1%, from $69.5 billion in 2005 to $107.8 billion in 2009.
Strong revenue, uneven earnings
Despite the stronger revenue, Verizon’s earnings have been somewhat erratic. Earnings fell from $2.56 a share (or a total of $7.2 billion) in 2005 to $2.54 a share (or $6.0 billion) in 2006. Earnings rebounded to $6.9 billion in 2007, mainly because AT&T bought long-distance provider MCI, but per-share earnings fell to $2.36 on more shares outstanding. Earnings improved to $2.54 a share (or $7.2 billion) in 2008, but fell to $2.40 a share (or $6.9 billion) in 2009.
In the three months ended March 31, 2010, earnings fell 75.9%, to $0.14 a share (or a total of $409 million) from $0.58 a share (or $1.6 billion) a year earlier. Without unusual charges, earnings would have fallen 3.4%, to $0.56 a share. But revenue rose 1.2%, to $26.9 billion from $26.6 billion, because of 1.5 million new wireless customers.
Verizon’s high-speed Fibre-Optic Service (FiOS) continues to attract new customers. It now has 3.6 million FiOS Internet users, up 30.2% from a year earlier. It also has 3.0 million FiOS TV subscribers, up 36.6% from a year ago.
The company’s long-term debt of $54.4 billion is 67% of its market cap. That’s higher than AT&T’s debt, but still manageable. The stock trades at 12.7 times the $2.29 a share it should earn this year.
Verizon is a buy.