AT&T (T 1.04%) benefits from operating in the U.S., one of the world's largest smartphone markets. However, the market is already mature, with a penetration rate over 80%. And AT&T battles fiercely for customers against Verizon and T-Mobile.
How is the company going to grow in such an environment? Is there still opportunity for AT&T to deliver big gains for investors? Let's take a look at what AT&T has to offer.
Best-laid plans disrupted
AT&T's growth strategy has involved building out its 5G network, and coupling that network with an entertainment empire that can attract subscribers and encourage device upgrades. The company has layered advertising technology over this ecosystem to generate insights that it's used to grow its advertising revenue.
In 2019 that strategy seemed sound. AT&T achieved record free cash flow of $29 billion last year, up 30% year over year. The company accumulated massive debt to acquire media assets DIRECTV and Time Warner, Inc., now called WarnerMedia -- but it had a plan to pay down that debt while growing revenue and free cash flow.
Then the novel coronavirus pandemic struck. First-quarter revenue fell from $44.8 billion to $42.8 billion. WarnerMedia dropped $1 billion in revenue year over year to $7.4 billion as it suffered from pandemic-induced theater closures and the loss of advertising revenue from the cancellation of lucrative sporting events, such as the NCAA March Madness tournament. The company's core telecom business saw store closures that reduced equipment sales by 8% year over year to $3.4 billion.
Suddenly AT&T found itself looking at how it can continue to reduce its debt load amid the revenue decline. Reports circulated of the telecom titan's plans to lay off 4,700 workers, close 250 store locations, and sell WarnerMedia's gaming division.
Road to recovery
The company's core telecom business is AT&T's key to bouncing back. Its 5G network will be nationwide this summer. As 5G becomes more widely available, customers will be incentivized to upgrade devices, and equipment sales will pick up. Research firm Gartner estimates 5G mobile phones comprise 12% of mobile phone shipments worldwide in 2020, but that will grow to over 50% by 2023.
AT&T also charges more for use of its 5G network. Because it's faster than the current 4G, it's ideal for streaming media, and can support more devices accessing the internet. The company's customers are already migrating to unlimited data plans, which pushed up AT&T's wireless service revenue 2.5% to $14 billion in the first quarter.
These signs point to additional revenue growth once 5G is widely available. The company already bundles 5G access with its new streaming service, HBO Max, as an incentive for customers to upgrade.
AT&T's challenge lies in capturing its fair share of 5G customers from its rivals, which could mean price cuts that eat into profit margins. Still, AT&T experienced four consecutive quarters of revenue growth in its wireless services, proving it can find success in a competitive market.
The bottom line
AT&T possesses the ingredients for success, and is a worthwhile investment. Its 5G network, extensive WarnerMedia content library for streaming, and Xandr, its digital advertising platform, all possess great potential.
But that potential won't unlock big investor gains until AT&T gets its debt under control. That's the biggest factor affecting the company's financial health right now. The company had over $160 billion in debt at the end of Q1, and in April AT&T took on an additional $5.5 billion in loans to provide further financial insurance against the uncertainty injected by the pandemic.
Until the debt load becomes manageable, it blocks AT&T from unlocking the value in its business and producing big gains for investors. Given the size of the debt, it will take time for AT&T to whittle it down even without the current economic uncertainty.
For the patient investor, AT&T's attractive dividend, currently yielding 6.95%, can provide an incentive to invest -- but the stock won't deliver outsized returns in the immediate future.