AT&T's Kindest Cut

Pressure is mounting. It looks increasingly likely that AT&T (NYSE: T  ) , struggling with shrinking revenues and earnings, will be forced to make a sizable dividend cut. Of course, shareholders who own Ma Bell for its safe, secure, and, best of all, hefty dividend yield are horrified by this prospect.

My response: AT&T investors should have seen this coming.

It's been an awfully long time since AT&T shares were a secure place for investors' money. For years now, the company has been taking daring steps to reinvent itself. It went into the computer business. It took on huge amounts of debt to get into cable services -- the same businesses it later sold to Comcast (Nasdaq: CMCSA  ) . To raise money, it unloaded Lucent Technologies (NYSE: LU  ) , NCR (NYSE: NCR  ) , and AT&T Wireless (NYSE: AWE  ) . Now, to slash costs, AT&T says it will stop promoting its still-lucrative residential long-distance business -- another potentially perilous move.

Face it. These kinds of goings-on over the years has made AT&T less of an investment of safety and more of an investment of risk. Widows and orphans have been dashing for the exits; AT&T lost its blue-chip status long ago.

Its steadily rising dividend yield should send shareholders the message. Companies that pay a dividend are effectively paying investors for some of their risk. AT&T's whopping 6.7% yield offers a strong and clear danger signal.

It's hard to feel safe with payout coverage of just of 0.54%. AT&T's $0.95-per-share dividend payout far exceeds the estimated $0.52 it will earn this year. In other words, it will need to dig into retained earnings from last year to pay this year's dividend.

With still-healthy cash flows, AT&T can probably manage the dividend payment this year, but for how much longer? It has revised its outlook for 2004. Revenues will fall 13% from $34.5 billion in 2003 and operating income will plunge to about a third of last year's $3.9 billion. That dismal forecast has prompted ratings agencies Moody's and Fitch to downgrade its bonds to speculative junk grade.

If AT&T hopes to keep going, every penny will count. Cash otherwise used for dividends could be used to pare down debt and invest in the latest network technologies needed to fulfill its plans of competing in the business market. Besides, AT&T's pre-dividend cash flows represent a juicy target for a leveraged buyout house. If it doesn't cut its dividend, financial operators Kohlberg, Kravis & Roberts -- rumored to be circling for a takeover -- certainly will.

Perhaps it's time management does shareholders a favor, and gives them the straight goods: "We haven't been your old AT&T for a long time now. We've been putting your shares at risk and we plan to continue doing so until we finally find a business where we can finally achieve some decent growth. To get there, we will need more cash. That means we have to put an end to this daft dividend."

Yield-hungry AT&T investors need to stop living in the past. A steep dividend cut is overdue. Without it, shareholders could be headed for even more trouble.

There are companies out there paying big dividends with solid business operations to back them up. Want to learn about them? Sign up for a free trial to Mathew Emmert'sMotley Fool Income Investorto learn more.

Fool contributor Ben McClure hails from the Great White North. He doesn't own any companies mentioned here.


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