AT&T (T 1.88%) is juggling a lot of things right now. After missing analyst expectations in the third quarter, the company pushed forward to announce one buyout and execute another. Meanwhile, smaller telecom rivals launched campaigns to steal subscribers from AT&T and Verizon, and the regulatory environment is in flux.
To clear the air regarding some of these issues, AT&T executives hit the road. Speaking at industry conferences from coast to coast, Ma Bell's C-suite leaders presented their take on these issues and much more.
Here are five of the most important things AT&T's executives wanted to tell you. Sorry, they didn't discuss the ongoing wireless spectrum auction due to a quiet period the FCC enforces around that event. But there was still plenty to talk about.
AT&T CEO Randall Stephenson. Source: AT&T.
The big picture behind DIRECTV
Starting in mid-November, AT&T CEO Randall Stephenson hit the Wells Fargo Technology, Media & Telecom Conference in New York City.
The discussion with Wells Fargo analyst Jennifer Frizsche quickly turned to AT&T's pending buyout of satellite TV operator DIRECTV (DTV.DL), and Stephenson explained exactly why he's interested in that asset:
We have a TV business that is losing money, and DIRECTV was the most logical transaction I've looked at in a long time because acquiring DIRECTV, bringing their content cost structure onto our TV business, makes our TV business certainly profitable. As you point out, it certainly makes us a meaningful player in the linear TV business. In fact, post-DIRECTV, we will be the largest pay TV provider in the world.
And so it makes us not only profitable in video across the board, but it gives us a nationwide ubiquitous TV footprint. Today, our TV footprint is a bit spotty. It's where we built out the TV capability. With DIRECTV, we cover 100% of the United Sates. That overlaps very nicely with a 100% coverage of the United States with our our mobile broadband business. With the mobile broadband build-out, we are talking about rural America. It gives us a very nice overlap of broadband with a TV product that is a best-in-class TV product, best-in-class content cost, best-in-class margin.
So, in Stephenson's mind, the biggest benefits of the DIRECTV acquisitions are an overall profitable TV service as DIRECTV's economies of scale start applying to U-Verse, as well as a more complete service offering outside of AT&T's wireline service areas.
I would add that DIRECTV also extends AT&T's reach in Latin America. That's why the recently announced buyout of Mexican wireless operator Iusacell makes more sense if the DIRECTV deal is completed. A complete package of mobile and television services is much more valuable than just one of these products, after all.
Fighting the price wars
Regarding the low-price assaults being mounted by Sprint and T-Mobile, Stephenson didn't see much need to join the fray:
Pricing is going to keep moving. We'll have to continue responding. So somebody asked me, what's T-Mobile or Sprint going to do? I have no idea. These things are open-field running. They're going to do what they do. And if we need to respond, we will. We're going to preserve the customer base, but we don't think we need to be a pricing leader in this premier smartphone customer base to the extent that we want to get aggressive on pricing.
In other words, don't expect AT&T to lower the lance for a full-tilt pricing attack on its smaller rivals. Much like Verizon, AT&T prides itself on offering a larger and better network, and it shouldn't have to pair this quality with rock-bottom pricing in order to attract subscribers.
That argument isn't crazy, but Stephenson will still always have to balance his margins against the potential for faster growth. As the wireless industry matures, the growth transforms into customer retention. How many high-margin subscribers can Stephenson afford to lose before responding with lower service and device prices?
That's a question for the ages. For now, don't expect Ma Bell to execute any drastic price drops.
Debt targets and cash flows
Four weeks later, AT&T CFO John Stephens showed up at the UBS Global Technology Conference just three blocks away from Stephenson's appearance.
First, he spoke about how AT&T is thinking about debt levels and cash flow allocations these days:
We do have some big investments coming up. And these investments -- Iusacell, DIRECTV -- will push our target of 1.8 net debt to EBITDA range and push us above that. We've been in this situation before and have been able to get back to our targeted debt levels rather effectively. That will be the focus of how we use free cash flow after dividends over the next three years.
As you've seen us do in the past we've come back down very effectively, focusing all our free cash flow over dividends to pay down debt and to get it back to that acceptable range which in our case right now is the 1.8 net debt to EBITDA range. So you will see us do that. That will be our focus.
AT&T has indeed seen debt ratios rising uncomfortably high in the past, only to push them back down again:
T Financial Debt to EBITDA (TTM) data by YCharts.
In the past, these adjustments have been a combination of higher EBITDA profits and large debt repayments. This time, Stephens is aiming for very generous debt retirement budgets to counteract the mountains of new debt from the DIRECTV transaction.
DIRECTV itself comes with $17 billion of net debt, and AT&T could tap the bond market for more than $7 billion of fresh financing for the deal.
And it's not like AT&T can just sit on its hands while the debt pile grows. Allowing the debt-to-EBITDA ratio to climb above 3.0 would trigger defaults on much of AT&T's existing debt and an existential crisis for the company itself.
So Stephens has to have a plan for flattening out the debt balance, and it's all about quick repayments powered by excess cash flows. Don't expect any miraculously large dividend increases until that debt-shrinking process is complete.
AT&T CFO John Stephens. Source: AT&T.
Is $18 billion not enough?
On that note, AT&T has lowered its capital expenses from $21 billion in 2013 to an expected $18 billion for all of 2014. UBS analyst John Hodulik asked Stephens if this drastic reduction might actually add risk to the stock. Shouldn't AT&T be spending more on its wireless network upgrades and maintenance?
Stephens shrugged this risk off with a laugh:
In the course of this conversation I will spend $2 million in CapEx, $50 million a day -- every day of every week of every month, every year -- it's $1.5 billion a month. We're going to be the leading investor in the United States at that with $18 billion of investment in capital in the U.S. So I am sensitive, as you might imagine. You can talk to my network guys, you can talk with some of our business partners; I don't view it as a cut, I view it as an adjustment to more normal levels.
Touche, Mr. Stephens.
AT&T is indeed the biggest spender in America when it comes to capital expenses. It's not even a close race. According to data from S&P Capital IQ, the company currently outspends Verizon, in second place, by nearly 30%.
Even if AT&T pulls back a little bit from that breakneck investment pace, it will still be an unparalleled network builder. The last couple of years have seen a massive investment in 4G LTE networks, and that's what Stephens is backing away from now.
Ask again when the next, next-generation network technology pops up...
John Donovan, AT&T's SVP of architecture and technology. Source: AT&T.
What's so great about 4G networks?
Finally, AT&T SVP of architecture and technology bounced clear across the country to San Francisco, where Barclays held its global technology conference in mid-December.
There, John Donovan explained why AT&T is champing at the bit to retire its aging 2G networks in favor of newer, faster, and more efficient 4G alternatives:
Crazy as it sounds, we still have millions of customers on the 2G network and some of those customers are using old flip phones, but then there is others that are machine-to-machine applications. And so we've already announced a shutdown date on that, December 31 of 2016, and that will free up five megahertz to 15 megahertz depending on the market of additional spectrum that we can farm in. We'd really like to move that stuff not from 2G into the HSPA+, we would like to jump it right to LTE.
The trip from 2G to HSPA+, it's six to eight times more efficient and then the move from HSPA+ to LTE gets you another 50% efficiency or so. For us it's a really important play to run given the spectrum efficiencies that are available.
AT&T has committed acres of high-quality radio spectrum to technologies that, quite frankly, nobody should use anymore. Compared to the old 2G networks, 4G technologies like HSPA+ and LTE simply make far better use of their spectrum assets. A roughly tenfold increase in spectrum efficiency helps AT&T increase its service speeds, improve network reliability, and also lower the cost per megabit of data delivered.
Donovan went on to note that customers are generally happier with 4G LTE then anything else, which only adds to the technical benefits. "The LTE network is the preferred network and we get customers on there, they are happier, it's the most efficient use of spectrum that I've got today to deploy, it's also the most economical thing that we can do," he said.
That's why the big telecoms always run at the bleeding edge of new networking technologies. These upgrades improve the business case for wireless networking in so many ways. Thinking back to Stephens' financial discussion, it's also why analysts worry when AT&T drops its capital expenses drastically.
Again, this pause lets the company focus its efforts on the big DIRECTV acquisition, and the next technical breakthrough is always right around the corner. Smoke 'em if you've got 'em, right?
