Before the market opens on October 22nd, the management team at AT&T (T) is due to report financial results for the third quarter of the company’s 2020 fiscal year. In recent years, and especially over the past 12 months, the entertainment and telecommunications conglomerate has undergone significant changes. Between the launch of HBO Max, the company’s debt-reduction plans, its push to simplify its operating structure, and more, a lot has been going on. As we near the company’s third quarter release, there are a few specific items that investors should pay very close attention to. These will go a long way toward determining the health of the business and the prospects it offers long term.
AT&T’s place in the streaming wars
Streaming is all the rage these days. Though Netflix (NFLX) is the market leader, other companies have come to the foray. The Walt Disney Company (DIS), for instance, owns Disney+, which accumulated its first 50 million users in only five months and reached 60.5 million by early August of this year. Disney also controls Hulu and ESPN+. Streaming allows content owners and creators like Disney the ability to control their content as they see fit and to generate long-term robust cash flows.
In response to this movement, AT&T launched, earlier this year, HBO Max, which was priced at $14.99 per month. This is toward the high end of the market in terms of pricing, plus it’s an issue when HBO has nowhere near the brand recognition that a firm like Disney boasts. The picture is also complicated by the fact that AT&T’s other offerings, like HBO, cloud the situation some. We do know that in the first month of its launch, the service had 4.1 million users. About 1.1 million of these were wholesale subscribers, while the other 3 million were retail subscribers.
Due to how AT&T’s platform works, there’s a lot of uncertainty over just how good the streaming is for the firm. In theory, it could become a cash cow. Their pricing indicates that if the platform rises to 10 million new-paying users, it could generate around $1.80 billion in revenue per year. That starts to become serious money. Add in the business’s other streaming service, Crunchyroll, and the more than 3 million paid subscribers and 70 million registered users, and there’s an opportunity here for money for the business. Because of all of these facts, investors should pay very close attention to management’s own guidance when it provides earnings later this month.
IoT is a hot trend
Though it may seem like the world is at a standstill right now because of the COVID-19 pandemic, technology continues its unending march. One of the hottest trends at the moment is IoT. In addition to being a provider of 5G network coverage and fiber assets, another key area for AT&T on this front are its Connected Devices. The lion’s share of IoT connectivity will belong to companies that can provide simple, easy-to-use wireless solutions for the devices it runs on and other related needs in the year to come.
AT&T’s Connected Devices business warrants consideration here. Their leading product is the Harman Spark. As of the end of the business’s second quarter this year, it boasted 71.762 million subscribers on these devices. This is up 22.9% compared to the 58.387 million subscribers on them the same quarter of its 2019 fiscal year. The COVID-19 pandemic does seem to have slowed growth some, because the net additions seen by the devices in the second quarter this year compared to the first quarter was just 2.255 million. That’s a gain of only 3.2% sequentially. Paying attention to whether this growth strengthens up again or weakens more could go a long way toward determining AT&T’s prospects.
Watch cash flow and debt
So far, 2020 has been quite weak for AT&T compared to what you might expect. Year-to-date, revenue for its Communications segment dropped 3.7%. In the latest quarter, the drop was 4.7%. For its WarnerMedia segment, these declines were 16.9% and 22.9%, respectively. This top line performance is a bit challenging to assess because some of AT&T’s operations are in a long-term state of decline anyways, while other parts are experiencing growth irrespective of what the economy does.
Due to this weaker revenue, management has had to revise down their thoughts regarding the conglomerate’s cash flow for the year. In 2019, AT&T surprised investors in a positive way when the company said free cash flow totaled $29 billion. Today, management is guiding around $24.9 billion based on my estimates. Around 60% of this will go toward the firm’s dividend, leaving $9.96 billion, approximately, to allocate toward debt reduction and share buybacks.
In the second quarter this year, AT&T announced that it had managed to reduce net debt over a three-month window by $2.3 billion, lowering its net leverage ratio to 2.6. Management wants to reduce that even more. So far in the first half of 2020, AT&T was responsible for $11.5 billion worth of free cash flow. This means that in the second half it should come up with around $13.4 billion of free cash flow if my estimates are to be right. Take out $7.47 billion for dividends and you get $5.93 billion between the third quarter and fourth quarter to put toward debt reduction if stock buybacks remain tabled. Another option to fuel debt reduction might be asset sales.
In recent weeks, we have heard rumors like AT&T possibly selling Crunchyroll for $1.5 billion or selling its video game unit, and more. Such a big move would permit more rapid debt reduction and it’s something investors should watch for. The company also, on October 13th, announced the completion of the sale of Central European Media Enterprises. Its ownership in the company resulted in it receiving $1.1 billion in cash, plus it now no longer has to backstop $575 million worth of the entity’s debt. Though transactions of this size may seem meaningless for a firm as large as AT&T, when added together they make an impact and they illustrate the hidden value controlled by the business.
Right now, there are a lot of moving parts when it comes to AT&T and its operations. As we near the firm’s third quarter earnings release, though, it becomes clearer to me that what matters most will be just a few key things. Chief among these, I believe, are the topics we discussed in this article. Investors should watch all of these closely because they will all point, in some way, to the prospects the conglomerate offers in the long haul.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.