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Did AT&T, Inc. Make a Serious Mistake?

AT&T Inc's (NYSE: T  ) stock fell more than 1% after it missed second-quarter revenue and EPS expectations. Unlike Verizon Communications (NYSE: VZ  ) , the company's postpaid subscriber additions failed to impress. Thus, AT&T's quarter might have revealed a major mistake on its part, which ironically involves T-Mobile (NYSE: TMUS  ) .

What we initially thought
If we go back to the first quarter of this year, there were serious reservations regarding the future performance of Verizon Communications. In that quarter, Verizon added just 549,000 postpaid net subscribers, which create long-term customer relationships, significantly lagging the 720,000 it gained in the year prior. 

Meanwhile, AT&T performed better than Verizon with 625,000, and T-Mobile outperformed both of its much larger peers with 1.3 million additions. Ironically, T-Mobile's sudden success is derived from an enormous breakup fee the company received when AT&T's attempted acquisition fell apart. Specifically, T-Mobile received cash and spectrum valued at $7 billion, which allowed it to improve its network and offer the most price-competitive mobile plans the industry had ever seen, such as $350 fees to new subscribers who left competing carriers. 

As a result, AT&T had begun to implement aggressive pricing strategies of its own, such as cutting mobile talk plans and bundling data plans like never before. The outcome was a rare showing of strength over Verizon, and a widespread belief that Verizon's future appeared questionable at best.

Did AT&T act too quickly?
With that said, Verizon has refused to adhere to the pricing war within the telecom space, even saying on record that the company will not buy customers. The strategy is gutsy, but could be lucrative if it works.

For example, research firm BTIG estimates AT&T's price cuts will result in a 10% decline in the company's average revenue per user. Therefore, to combat this decline, AT&T needs aggressive subscriber growth. Because after all, it's a lot harder to raise prices once they've been lowered versus the alternative, meaning AT&T has placed a big bet on its new strategy, one that needs to pay off. Conversely, Verizon didn't make this bet, meaning it can still grow if it can attract new subscribers despite higher prices.

Yet, AT&T's second-quarter results are showing that AT&T may have acted too quickly with its new approach, as it added 1.03 million post-paid subscribers. While this number exceeds the company's guidance for 800,000 net additions, it significantly lags the 1.4 million subscribers Verizon gained in the second quarter.

In other words, Verizon proved it didn't need aggressive discounting and a less-revenue-per-user approach to compete against T-Mobile, thus not allowing T-Mobile to dictate the state of the market. However, AT&T's quick-to-act pricing decisions have put it in quite a predicament, one where it can't raise prices, yet growth is not viable because of the declining revenue per user. In fact, BTIG predicts that AT&T's service revenue will fall at a 5% rate by the end of 2014, while Verizon's grows at a similar rate.

As for T-Mobile, it was a challenged company prior to the breakup fee from AT&T, so it has nothing to lose with such aggressive policies, and investors have responded well to its double-digit growth rate. However, AT&T's inability to outperform Verizon serves as yet another loss for the company following a hasty decision to keep up with T-Mobile, a problem it ironically created.

Foolish thoughts
The big winner in this equation is obviously Verizon, a company whose postpaid growth exceeded Wall Street's expectations, and made a stern statement to the rest of the telecom sector. Therefore, with more questions than answers surrounding AT&T regarding how it will weather this storm it created, Verizon most certainly looks like an investment that's poised for higher days ahead.

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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