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December 06, 2008

New Purchase: Why You Should Own AT&T

On Friday, December 5th, I purchased AT&T for Northlake clients and in my personal accounts. The following commentary appeared on RealMoney.com on December 3rd when AT&T was about $2 higher than the purchase price. When the shares pulled back after the the company announced job cuts, a buying opportunity was created. I slightly prefer AT&T to Verizon because it has a lower P-E ratio, more cost cutting opportunities and does need to finance a major pending acquisition.

AT&T (T) and Verizon (VZ) , the leading telecommunications companies in the U.S., both look attractive to own for the short and long term.

AT&T has a market cap of $164 billion with projected 2008 revenue of $124 billion. Verizon has a market cap of $91 billion with projected 2008 revenue of $97 billion. AT&T should end this year with about $64 billion in net debt. Verizon has about $43 billion in debt but needs to finance its $27 billion purchase of Alltel.

Both stocks have reasonably low valuations and good dividend yields, which provide downside protection. And both companies have recession-resistant business models due to the utility-like nature of most of their revenue streams. While competition is tough in all the businesses that both companies compete in, the only area that is clearly in secular decline is consumer wireline, where access lines are falling due to wireless substitution and inroads by cable companies.

Enterprise services to corporations represent about 25% of revenue for each company and currently face cyclical pressures. Wireless is the primary growth business, at about 40% of revenue, and advanced consumer services such as TV and high-speed Internet are also growth businesses, even though they account for only 5% of revenue.

Why You Should Own AT&T Now

These revenue mixes should enable both AT&T and Verizon to at least maintain flat revenue and earnings growth in 2009 and probably eke out small gains. Estimates call for low-to-mid single-digit gains on both metrics. Investors will seek out the defensive nature of AT&T and Verizon while also understanding that the long-term growth story is improving as the business mix continues to shift toward the growth businesses.

Long-Term Drivers

Recently, Jim Cramer succinctly nailed the long-term attraction of AT&T and Verizon. He noted that both companies' competitive positions are improving rapidly as they come to dominate the business-facing telecom industry and develop an oligopoly with the cable companies when facing consumers. Further, Jim notes that the trend toward wireless and digital communication benefits the telcos.

The shift to wireless and digital communication is evident in the revenue mixes and gives AT&T and Verizon a chance to grow in 2009 despite the massive economic headwinds. Both companies also have the opportunity to use their relatively strong stock prices and still-open access to credit markets to further enhance their digital positioning via acquisition. For example, Alltel is a win for Verizon, and AT&T has quietly scooped up a few small wireless players to enhance its geographic footprint.

What Could Go Wrong

The biggest risk facing AT&T and Verizon is that the wireless business could slow down more than expected. Trends in voice are already under pressure, with average revenue per user falling and new subscriber growth slowing. The shift to smartphones hurts margins in the near term as phone subsidies soar. This is a worthwhile investment if data growth continues. If wireless data growth, which has been near 50%, slows more sharply than expected, the defensive nature of AT&T and Verizon will be seriously undermined. Keep an eye on smartphone sales for any sign of slowing.

A second fear is that enterprise spending proves more cyclical or has a deeper cyclical downturn than expected. A key driver of enterprise is employment at larger corporations, so unemployment rising to the worst predictions of 10% would likely lead to estimate cuts that take away the defensive veneer of AT&T and Verizon.

The Bottom LIne

AT&T and Verizon provide near-term defensive characteristics with improving long-term growth profiles as communication continues its relentless shift toward wireless and digital applications. High current yields and above-average financial strength provide assurance for nervous investors.

Posted by Steve Birenberg at December 6, 2008 09:15 AM in Telephone