By: Ben Stadelmann, September 11, 2023
It’s inevitable for a publicly traded company to garner a variety of opinions. Whether it be a difference over investment strategy or the simple fact that a buyer will have an opposing view from the seller, “this is what makes it a market,” as the old saying goes.
Sometimes, however, the gap between the optimists and pessimists becomes a yawning chasm. The bulls and bears feel a need to not just voice their opinion, but to do so vigorously, frequently hurling scorn from either side of the canyon.
Ben can’t think of another occasion in his over 40 years of investing experience that matches the volcano of verbiage spewed by analysts over the past year about one particular enterprise. It may surprise you to find that the subject of these arguments is none other than blue-chip telecom AT&T Inc. T-N +0.21%increase .
At Seeking Alpha, the online investment community, the bears fire off missives with stinging headlines such as “Dead Money Walking,” “The Knife is Still Falling,” “The End is Nigh” and “You Were Warned.” The bulls answer confidently with smug retorts: “Put a Tiger in the Tank,” “Mr. Market’s Big Gift,” “Time to Pounce” and “Buy Before it Soars.”
While it’s daunting to summarize such a bounty of investor information, here’s our best shot:
The bear case points out AT&T’s long history of poor performance and a dividend cut last year that sucker-punched income investors. Management are apparently a bunch of bozos who have sleepwalked from one disastrous acquisition to the next, while accruing a massive debt load. In an era of elevated interest rates, this is a ticking time bomb. After spending too little on spectrum, competitors T-Mobile TMUS-Q +0.18%increase and Verizon VZ-N +0.68%increase now have the upper hand. Some argue that telecom service has become commoditized and suggest that AmazonAMZN-Q -0.15%decrease will enter the fray and, with its scale and marketing clout, will eat AT&T’s lunch.
The bulls counter that AT&T is a prodigious generator of free cash flow, US$16.2-billion in 2022, and on track for a similar haul this year. The generous dividend (currently yielding 7.6 per cent) is easily covered by a payout ratio of only 44 per cent. This not only provides a margin of safety, but allows leeway for both debt reduction and substantial investments in capacity. Current management has learned from past mistakes, and with the spinoff of Warner Bros. Discovery Inc. WBD-Q -1.47%decrease , the telecom will get back to its core competency, and regain its mojo.
The view here is that both sides make some excellent points. Ben was content to watch and wait, while the stock had a brisk rally of about 40 per cent off the October, 2022, lows, then went into a steady downtrend. What took him off the sidelines in July, with a purchase at US$13.86, was a story in The Wall Street Journal about the lead sheathing of transmission cables, mostly buried underground starting in the late 1880s and phased out by the 1970s.
This environmental issue has been percolating for decades, but Bell’s role was news to the general public. Suddenly analysts were doing back-of-the-envelope estimates of potential liability for soil and waterway contaminationand, amid analyst downgrades, the stock got hammered.
The WSJ story leaned heavily on the premise that there is no known level of lead exposure that is completely safe. The journalists dramatically illustrated the epic scale of the potential problem by observing that: “By 1956, the Bell System was using around 100 million pounds of lead a year, according to a Bell document. That’s heavier than more than 6,660 male African elephants.”
That sounds pretty bad, but perhaps a better comparison – and one that would provide a little more context – would be with the amount of lead used in gasoline, back when this additive was allowed. The tally is reckoned to be in the millions of tonnes, compared with the roughly 45,000 tonnes Bell used in its cables annually. And that mountain of lead in gasoline was effectively aerosolized and distributed by cars and planes over the entire planet.
According to a study by the Electric Power Research Institute, lead does not corrode much because of the formation of a naturally occurring film on its surface. Even if it does deteriorate, any contaminationcannot move easily through soil. The research concluded that potential risks to human health and the environment are extremely low and the replacement of the cables is not warranted.
Though herds of lawyers will no doubt disagree, the publication of the article erased about US$15-billion off the company’s market cap, sending the stock to a 30-year low. This looks like an overreaction.
The “buy” thesis is that AT&T is essentially a turnaround situation. Yes, the company has been dreadfully managed and made some terrible deals. (Welcome to the club, you can bring the snacks on Tuesdays.) This kind of thing is our bread and butter because virtually all of the enterprises we purchase have problems that need to be dealt with. For us, it’s a matter of finding that inflection point where the company is on the way to righting its wrongs.
AT&T doesn’t have to be the best and brightest telecom, it just needs to get back to a reasonable level of respectability. As returns on past investments in 5G roll in, with some belt tightening it should be possible to pay off debt as it comes due. Achieving a middle ground somewhere between optimists and pessimists could be enough to float the stock to a target of US$24 in a few years, while collecting a nice dividend along the way.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter