December 26, 2018 / 7:15 PM / 6 months ago

Breakingviews - Overleveraged AT&T is a magnet for activists

NEW YORK (Reuters Breakingviews) - AT&T has piled on debt to add entertainment to its core telecommunications business. It’s a risky strategy for Randall Stephenson, the U.S. group’s chief executive. Breakingviews imagines a missive sent sometime in late 2019 from a restive shareholder.

An AT&T Logo is pictured as a U.S. flag flutters in the foreground in Pasadena, California, January 26, 2015. REUTERS/Mario Anzuoni

Mr. Randall Stephenson

Chairman, Chief Executive Officer and President

AT&T Inc.

208 S. Akard St.

Dallas, Texas 75202

Dear Mr. Stephenson,

I am Olenna Nestor. My fund Braavos Capital Management beneficially owns approximately 1 percent of AT&T’s shares, worth about $2 billion. I wish to make known my concerns regarding your leadership of the second-largest wireless carrier in the United States.

Let’s start with your stock. In early December 2018, your company’s share-price performance had lagged peers like Verizon Communications and Comcast over time periods from five years to three months, and investors valued your expected earnings less highly than your rivals’. Unfortunately, your relative performance and valuation haven’t changed.

(See graphic )

In my view, this is related to the onerous $180 billion of debt you piled on the company, most recently to acquire Time Warner for $85 billion. AT&T remains the most heavily leveraged business outside the financial sector.

Last November, you said reducing net debt to 2.5 times EBITDA from nearly three times was a top priority. Despite earmarking some $20 billion for this, the idea was that a $14 billion dividend would still be doable in 2019, thanks to an estimated $26 billion of free cash flow and the sale of assets like your 10 percent stake in Hulu.

Approaching a year later, hindsight is painting a different picture. AT&T weathered past downturns thanks to the fairly steady wireless business. The economic slowdown we are experiencing now is having a predictably larger effect, even though it’s not yet dramatic. That’s because after your Time Warner deal, media came to represent roughly one-third of adjusted EBITDA, and it’s far more sensitive to market conditions.

Your efforts to justify the $48.5 billion you shelled out for DirecTV are looking underpowered, with the rapid decline in subscribers outpacing AT&T’s ability to offset that with a much cheaper streaming product. Time Warner only amplifies the problem, because the unit’s revenue is partly advertising-dependent and therefore closely linked to GDP.

(By the way, the name of your ad platform, Xandr, rivals only Verizon’s Oath in silliness. At least that company’s CEO Hans Vestberg had the good sense to change it.)

AT&T’s credit ratings from Moody’s Investors Service and Standard & Poor’s still hang a few notches above junk status, but a downgrade would be something markets simply can’t absorb. Your capital expenditure and dividend would have to be reduced. I can’t help but think of General Electric. Chief Executive John Flannery sliced the payout in November 2017, but that proved only the beginning of the company’s dark times. GE’s market value fell roughly 60 percent in the subsequent year. Flannery had to quit, as I am sure you recall.

AT&T is not yet in such dire straits. But you and your board are spinning too many plates and lack the necessary expertise. Appointing a director who understands media might be a start. Some of the big names are too close to your competitors. How about Peter Chernin, though? He worked for Rupert Murdoch a decade ago and has the kind of experience you need.

You survived the misjudgment of pursuing T-Mobile US when regulators blocked the deal in 2011. You overpaid for DirecTV in 2015. You squeaked Time Warner past regulators. Winter is coming, as they say in HBO’s “Game of Thrones.” I hope to engage in conversations with you, the board and management to help you avoid devastation.

- This is a Breakingviews prediction for 2019. To see more of our predictions, click


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