AT&T (T) reported its first quarterly results since Northlake took a long position in client accounts in July.  Virtually across the board, the results slightly exceeded estimates leading the company to modestly increase its 2021 guidance for financial results and subscriber counts.  Our thesis is built upon a hated company that is showing improved execution on financial and operating fundamentals, while also making smart strategic divestitures to focus on its connectivity business.  3Q21 results fully support our outlook for T shares.

Stock Reaction: Investors are not yet embracing the turnaround at T.  The shares initially traded up, building on gains from the prior day when Verizon also reported confidence-building results.  However, the shares reversed to close slightly lower along with Verizon and T Mobile.  There remains skepticism about recent industry growth in mobile phones given penetration rates over 100% and intense competition between the big three telcos and cable companies now offering wireless services.  Investors have a little more faith in T’s aggressive buildout of its fiber network to provide broadband for consumers and small businesses.  Finally, there is a general lack of interest in T due to the still complicated financial reporting and uncertainty about how the merger of T’s Warner Media segment with Discovery Communications will work.

Earnings Analysis: T has three major segments – wireless, consumer wireline, and Warner Media.  Each segment reported slightly better than expected 3Q21 results for revenue, EBITDA, and subscribers.  T has now strung several good reports as new senior management builds credibility.  In wireless, T is growing subscribers at industry-leading rates, matching long-time growth leader T Mobile. T is using promotions more like T Mobile’s Uncarrier branding approach.  So far, it is paying off with improved financial performance.  T is also benefitting from its FirstNet network for police, fire, EMT’s and other emergency responders.  In consumer wireline, T is now an insurgent as its fiber network is passing 30 million homes with many millions more to come.  This is showing up in upper single-digit revenue growth and a turn to positive EBITDA as the subscriber count scales.  Better gross adds are occurring although the Street needs to see more on this front since so many subs are converting from T’s slower DSL broadband services.  Warner Media seems clearly established as a top three player in streaming with HBO Max.  Management has simplified the services to focus solely on HBO Max which is helping the approach to distribution.  Despite taking HBO Max off distribution on Amazon Prime Video (cost 3-4 million customers), subscriber additions still exceeded estimates.  Management raised subscriber guidance for yearend 2021.  EBITDA is coming under pressure as the ramp in content spend continues.  This spending should peak next year.  All in, Warner Media is at least on track pending its merger into Discovery Communications in mid-2022.

Target Price: When we purchased AT&T in July, we established a $36 target based on the sum of the company’s 71% share of new Discovery Communications and the new connectivity-focused AT&T that will emerge post the merger closing.  We still see this upside but point out that even a target of $30 provides a 25% total return from current prices, supported by a hefty dividend of 8% until the merger closes and nearly 6% after.  Management must continue to build credibility with continuing stronger financial and operating results.  Most analysts are cautious on T but there is clear improvement in sentiment (albeit grudgingly) as we read the research reports.  The combination of skepticism, improving investor sentiment, and steady strength in financial and subscriber metrics is what attracts us to T.  While we wait, we get paid a very healthy dividend when money markets still pay almost nothing and 10-year Treasury notes have an annual yield of 1.6%, which is the yield T pays each quarter.

AT&T is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  DIS is a net long position in the Entermedia Funds.