Wireless giant AT&T (NYSE: T) has made some questionable moves in the past few years. It paid $67 billion for DirecTV in 2015, and it doled out another $85 billion in 2018 for Time Warner, all in an attempt to transform itself into a media conglomerate. The company now owns some top-notch media assets, but its strategy, especially around streaming, is an incoherent mess.
These acquisitions have dialed up the risk for AT&T, since they've loaded up the balance sheet with a scary amount of debt. Total debt was roughly $170 billion at the end of the second quarter, not counting another $21 billion in pension obligations. That's the most debt for any nonfinancial and non-government-owned company in the world, according to Bloomberg.
Investors haven't really bought into the story AT&T is trying to tell. The stock trades below its multiyear high, and it goes for just 10 times the company's guidance for full-year free cash flow. That's a big discount to the broader market, but it reflects legitimate concerns about debt and strategy.
Billionaire Paul Singer and his Elliot Management are concerned about AT&T's strategy as well. The hedge fund unveiled a $3.2 billion stake in the company on Monday, and it called for big changes in a letter to its board of directors. If implemented, Elliot believes the stock could soar past $60 per share.
Deal making gone wrong
Elliot called AT&T "one of the world's most important companies and one of America's proudest technological stories" in its letter to the board, but also detailed missteps and setbacks that have hurt shareholder returns. Over the past decade, Elliot claims that AT&T stock has underperformed the broader market by more than 150 percentage points.
The company's acquisition strategy is Elliot's biggest complaint. The most damaging deal, according to the hedge fund, was actually one that failed. AT&T tried to acquire T-Mobile in 2011 for $39 billion, but the deal was blocked by regulators. AT&T paid T-Mobile a multibillion-dollar breakup fee and handed it a roaming deal that helped make T-Mobile a tougher competitor in the years ahead.
Elliot also criticized the acquisition of DirecTV, which occurred "at the absolute peak of the linear TV market." AT&T has been hemorrhaging TV subscribers, and it's even been losing subscribers for its DirecTV NOW on-demand service, which is now known as AT&T TV NOW. Confusingly, this service is separate from AT&T TV, a different service offered by the company.
On the Time Warner deal, Elliot praised the company's "collection of some of the world's premier media assets." But it pointed out that AT&T has yet to convincingly explain why it needed to own Time Warner. The hedge fund remains cautious on the benefits of the deal, especially given that it's already been nearly three years since the deal was first announced.
"We firmly believe that AT&T's M&A strategy has not only contributed directly to its profound share price underperformance, but has also caused distractions that have contributed to the Company's recent operational underperformance," reads Elliot's letter.
On the operational front, Elliot pointed to stumbles with the original exclusive iPhone launch in 2007, a sluggish rollout of 4G LTE, and a lack of clear brand positioning in the minds of consumers as problems that have contributed to weak stock performance over the past decade.
The opportunity ahead
Elliot's plan for AT&T has four pillars:
- Improved strategic focus: Sell businesses that are outside the core business, with possibilities including DirecTV, the Mexican wireless business, and parts of the wireline business. On top of raising capital to pay down debt, this will reduce distractions.
- Operational improvements: Eliminate layers of management, reduce wasteful spending, cut spending on functions like finance, HR, and marketing, close some retail stores, and consolidate offices and network centers. Elliot pointed to substantially higher revenue per employee at rival Verizon as evidence that AT&T is inefficiently run.
- Formal capital allocation framework: Refrain from significant acquisitions, grow the dividend by approximately 2% annually, and split the remaining cash flow equally between paying down debt and making share repurchases.
- Enhanced leadership and oversight: Elliot called the current leadership team accountable for AT&T's issues over the past decade. The plan urges the separation of the CEO and chairman roles, the formation of a strategy and operations committee of the board, and the addition of qualified directors with specific domain expertise.
Elliot believes AT&T stock could surpass $60 per share if its plan is implemented, driven by 10% annual earnings-per-share growth and an expansion of the depressed price-to-earnings ratio. "If done successfully, the opportunity is historic," concludes the letter.
Whether AT&T will act on any of Elliot's suggestions is an open question. Elliot's stake isn't nearly big enough on its own to force action, but the hedge fund could get enough supporters of the plan elected to the board to alter the company's strategy.
At $60 per share, AT&T would trade for a little less than 16 times its free cash flow guidance for 2019. That's a realistic valuation, assuming the company can regain the confidence of investors, but that will be a difficult task if it sticks with its messy media strategy. The Elliot plan may be just what AT&T needs for the stock to break free from its multiyear malaise.
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