AT&T (NYSE:T) was once considered a safe dividend stock for conservative investors. But over the past five years, the telecom giant's stock price declined more than 30% as the S&P 500 more than doubled.
Even after factoring in reinvested dividends, AT&T generated a total return of negative 10%, compared to the S&P 500's total return of nearly 130%. That dismal return makes AT&T seem like a poor investment, but could it finally perk up over the next few years? Let's review three reasons to buy AT&T -- as well as one reason to sell it -- to see if it's a contrarian play.
1. A "new" AT&T will emerge next year
AT&T's stock underperformed the market for three main reasons: It faced tough competition in the wireless market from Verizon (NYSE:VZ) and T-Mobile (NASDAQ:TMUS), its pay-TV business bled subscribers to streaming services, and attempting to stop that bleeding with its debt-fueled takeovers of DirecTV and Time Warner caused even bigger problems.
AT&T spun off DirecTV (including AT&T TV and U-verse) into a new company in August, and announced it would spin off Time Warner (WarnerMedia) into a new company through a merger with Discovery (NASDAQ:DISCA) (NASDAQ:DISCK) by mid-2022.
After that spin-off concludes, the "new" AT&T plans to upgrade and expand its 5G networks to keep pace with T-Mobile -- which surpassed AT&T as the second-largest wireless carrier in the U.S. after merging with Sprint last April. AT&T's current investors will receive shares of the new media spin-off.
These two separate companies might fare better on their own with simpler business models than as a combined entity. The company expects the "new" AT&T's revenue to rise at a low single-digit percentage compound annual growth rate (CAGR) from 2022 to 2024, and for its adjusted EBITDA and adjusted earnings per share (EPS) to grow at a mid-single-digit CAGR.
Those growth rates would make AT&T more comparable to Verizon, which generated more stable growth in recent years because it didn't attempt to build a media and streaming empire with big acquisitions.
2. Prioritizing growth over dividends
The new AT&T will spend about $8 billion of its annual free cash flow on dividends, compared to nearly $15 billion in 2020. That statement implies its current forward yield of 7.6% will drop to 3% to 4%.
AT&T says the upcoming dividend cut will reflect its spin-off of WarnerMedia, but the new media company probably won't pay a dividend if it plans to fund new content and compete more effectively against Netflix and Disney in the streaming wars.
This might initially seem like bad news for income investors, but AT&T will still pay a higher dividend than many other blue-chip stocks. Meanwhile, the new WarnerMedia/Discovery spin-off can spend more of its own cash on new shows and movies instead of funding AT&T's massive dividend. In other words, both companies could improve as they prioritize their long-term growth over big dividend payments.
3. The stock is still dirt cheap
AT&T trades at less than nine times forward earnings. Verizon and T-Mobile have forward price-to-earnings (P/E) ratios of 10 and 39, respectively. The bears will argue that AT&T's past mistakes justify its discount price, and that its turnaround plans could still face plenty of hurdles.
However, AT&T's business arguably passed a nadir last year as the pandemic battered WarnerMedia's business and caused consumers to postpone their upgrades to new 5G phones. Those pandemic-related headwinds are waning, and AT&T is trying to rectify its past mistakes with DirecTV and Time Warner.
AT&T has also sold several of its non-core businesses -- including its Crunchyroll anime business, its Playdemic gaming studio, and its satellite TV business in Latin America -- to streamline its business and reduce its debt. If AT&T's plans pan out, the market might revalue its stock with a higher multiple.
The one reason to sell AT&T: Its management
AT&T's turnaround plans would be more inspiring if it brought in new leaders to lead the transformation. However, the "new" AT&T will still be led by John Stankey, who oversaw its disastrous integration of DirecTV and its misguided takeover of Time Warner as AT&T Entertainment's CEO before succeeding Randall Stephenson as the company's CEO last year.
Discovery's CEO David Zaslav will lead the new WarnerMedia spin-off. Zaslav has led Discovery since 2007, but it's also struggling to expand its new streaming service to pivot away from cable networks.
Therefore, merging two losers in the media space might not make a winner, and a less cluttered version of AT&T could still struggle to catch up to Verizon and T-Mobile. Without new leaders at the helm, AT&T and its new media spin-off could fare just as badly as the original company.
AT&T's upcoming spin-off might resolve some issues, but I'm not buying any more shares until I actually see some progress. The company's insular management has a dismal track record, and the spin-off could simply mask some of its underlying problems instead of resolving them with fresh ideas.