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July 24, 2007

Another Good Quarter for AT&T

While there were a couple of issues with AT&T's 2Q07 earnings report, overall I think the results were good with underlying trends supporting the investment thesis that has led the shares to gain by 33% since last fall. I think further gains lie ahead.

AT&T reported EPS of 70 cents, up 21% vs. a year ago, on revenue growth of 2%. Both figures were slightly above expectations. Revenue growth continued to improve as the mix shifts toward wireless and data across all businesses. Cost synergies continue to be at the high end of expectations, pushing margins to the top end of management guidance....

Wireless service revenues grew 14.9%, ahead of expectations, driven by a 67% increase in data revenues. Data revenues have plenty of upside as use is expanding well beyond text messaging and many subscribers use no or minimal data services. Net adds were 1.456 million, also ahead of expectations. Management was happy with the iPhone. Net adds and ARPU were particularly good for postpaid subscribers reversing some recent weakness and possibly allaying investor concerns. One weak point in AT&T's quarter was wireless margins which showed some pressure due to a mix shift toward more expensive phones, marketing costs for the iPhone, and possibly the iPhone revenue sharing agreement. More expensive phones should mean more data revenue so this might be a tradeoff with incurring.

Wireline revenues are still down on a year-over-year basis. Enterprise is improving, however, and could turn the quarter in the next few quarters. Voice declines are moderating and data growth continues. Consumer related revenues are still being pressured by high access line loss. The 6.7% decline in access lines is the other disappointment in the quarter as analysts had been looking for continued improvement. Growing reach of cable VOIP and wireless substitution remain the culprits.

U-Verse TV subscribers were up 38,000 a little ahead of estimates. Management believes it can reach 10,000 installs per week by the end of 2007. That would be a good number but probably not enough to upset the multichannel TV market. Amazingly, installation times for U-Verse are still over 7 hours!

DSL subscriber additions was the final weak point in the quarter. Net adds of 400,000 trailed estimates of 450,000 to 550,000. Management noted typical 2Q seasonality but I think that cable has reestablished its market share lead due to higher speeds and the triple play bundle.

AT&T completed its $10 billion share buyback in July a few months ahead of schedule. $125 million remains on the authorization and T intends to buy the stock.

Guidance for free cash flow in 2007 was raised by $1 billion to $5-6 billion. Most analysts were above guidance but this is still good news. Management also raised its operating margin guidance to the top end of the 23-24% range previously discussed.

I like T shares. The stock trades at 13 times 2008 earnings with a 3.6% yield providing support. Earnings growth in 2008 is projected at 13% and estimates could a few pennies low. Merger cost synergies make the outlook very predictable as an incremental $2 billion will appear in 2008 with another $1 billion in 2009. Decent predictable growth, improving trends due to mix shifts, wireless data growth, and free cash flow profile make T an attractive investment.

Posted by Steve Birenberg at July 24, 2007 10:31 AM in Telephone