Over the past two years, AT&T (T 1.02%) tried to reset its business by selling its non-core assets and spinning off DirecTV and WarnerMedia. It claimed that a big reversal of its media expansion plans would enable it to focus on upgrading its 5G and fiber networks to compete more effectively against its telecom rivals.
The last major step in that plan was the creation of Warner Bros. Discovery (WBD -2.17%) through a merger between WarnerMedia and Discovery. When that transaction finally closed on April 8, 2022, AT&T's investors received 0.241917 shares of WBD for each share of AT&T they held. Yet both stocks have slumped since they started trading separately on April 11 -- AT&T's stock has declined 25% while WBD's stock has fallen 47%.
Image source: AT&T.
The "new" AT&T initially impressed investors with the robust growth of its wireless business, which gained nearly 2.9 million postpaid phone subscribers in 2022, and the expansion of its fiber networks. But a lot of that growth was offset by the softness of its business wireline segment and its loss of non-fiber broadband customers. AT&T initially claimed it could generate $20 billion in free cash flow (FCF) in 2023, but it subsequently reduced that forecast to $16 billion. The company generated just $1 billion in FCF in the first quarter of 2023 as it racked up higher 5G and fiber expenses.
That anemic FCF growth raises red flags for AT&T's dividends and expansion plans, and rising interest rates drove investors toward more conservative income investments. AT&T's stock might seem dirt cheap right now at six times forward earnings with a whopping forward yield of 8.3%, but three other red flags might limit its near-term gains.
1. Amazon's potential entry into the wireless market
In early June, several reports claimed that Amazon (AMZN 3.43%) could roll out wireless plans at just $10 a month (or possibly free) for its Prime members. It reportedly held talks with Verizon (VZ 1.17%), T-Mobile, and Dish Network to build that service to secure the lowest possible wholesale prices.
Amazon subsequently shot down those rumors, while T-Mobile said it wasn't in active discussions to bundle its services into Amazon Prime. Nevertheless, the idea that Amazon could eventually enter the mobile race by partnering with one of AT&T's largest competitors was a chilling thought -- especially since the three major U.S. carriers (AT&T, Verizon, and T-Mobile) are still entangled in a margin-crushing price war. Amazon's support could easily tilt those scales in favor of AT&T's rivals.
2. The CFO's warning about its wireless business
AT&T's wireless segment gained 424,000 postpaid phone subscribers in the first quarter of 2023, marking its 12th consecutive quarter of adding at least 400,000 postpaid phone subscribers, but that streak could end in the second quarter. Speaking at a Bank of America conference in late June, CFO Pascal Desroches said AT&T would likely only add about 300,000 postpaid phone subscribers in the second quarter, which was far below the consensus forecast for 476,000 net adds.
That outlook still puts AT&T ahead of Verizon, which only added 201,000 postpaid phone subscribers in 2022 before losing 127,000 subscribers in the first quarter of 2023. But it raises even more doubts about AT&T's ability to achieve its closely watched target of generating $16 billion in FCF this year -- which Desroches insists it can still achieve.
3. The lead-sheathed cable controversy
Last but not least, AT&T and Verizon were both recently called out by a Wall Street Journal report which claimed the two companies exposed their workers and the environment to toxic lead-sheathed copper cables. Analysts at Goldman Sachs and Morgan Stanley initially estimated it could cost AT&T up to $4 billion to replace those legacy cables.
However, AT&T responded by claiming those lead-covered cables only accounted for about 10% of its total copper network footprint. It said two-thirds of that total was "either buried or in conduit, followed by aerial cable, and with a very small portion running underwater" -- and there would be "varying costs" for their removal based on the environment.
Based on those new estimates, Raymond James analysts pegged the total removal costs between $264 million and $1.2 billion, which would be stretched out at around $84 million a year. That would only represent 0.07% of AT&T's projected revenues this year, but this developing story could still tarnish AT&T's brand and weigh down its stock price.
What's next for AT&T?
AT&T is scheduled to post its second-quarter earnings report on July 26, and it will likely post some weaker-than-expected wireless numbers while providing clearer updates regarding its lead-covered copper cables.
On the bright side, AT&T might be able to offset some of that doom and gloom by generating higher-than-expected FCF growth demonstrating that it can still reach its target of $16 billion. But even if that happens, AT&T's stock will likely keep trading at that discount in this wobbly market until a few more green flags appear.
