AT&T: A Strong Buy for Income
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
AT&T (NYSE: T) is going into high gear in its attempt to boost its spectrum holdings and grow its 4G LTE network by announcing its plans to acquire NextWave Wireless (WAVE) for $600 million and obtain access to its spectrum licenses in the Wireless Communication Services (WCS) and Advanced Wireless Service (AWS) bands. As consumers demonstrate their preferences for smartphones and tablets which are increasingly data intensive, spectrum has become an important asset for wireless services carriers to avoid overload on their networks. The situation is expected to worsen with the expansion of 4G LTE networks, which are faster but use up more bandwidth. The more effective use of spectrum still does not have strong consensus as carriers, Congress and the FCC attempt to resolve the problem. The U.S. market continues to be dominated by Verizon (NYSE: VZ) and AT&T, with Sprint (NYSE: S) in a distant third position. Sprint's wireless network reached over 55 million users at the end of 2011.
AT&T also plans to phase out its 2G services to make more spectrum space for its new 4G technologies and has indicated that over the next four years, it will migrate its 2G users to more advanced devices and then discontinue these services altogether. But AT&T lags behind Verizon, which is already offering 4G LTE service to 230 million Americans spread over more than 300 markets. This is expected to grow by the end of this year to 260 million Americans in 400 markets. For the moment, AT&T's LTE services only extend to about 80 million Americans, which will expand to reach 150 million Americans by the end of 2012. In an attempt to resolve its spectrum woes, AT&T tried to acquire T-Mobile last year. But competitive concerns pushed the FCC to block the deal, and AT&T had to hand over more than $1 billion of spectrum in addition to $3 billion in cash to T-Mobile. At the same time, Verizon acted quickly and concluded spectrum deals with cable companies keen on keeping their spectrum out of the reach of AT&T.
There is no immediate prospect of spectrum auctions because, despite the approval of Congress for the auctions, much will depend on how the FCC views the TV spectrum that AT&T requires keeping competition concerns in focus. Moreover, TV broadcasters are not prepared to part with their spectrum so AT&T cannot depend on the auctions to resolve their long-term requirements. AT&T therefore has to consider hard decisions to make the best use of their available spectrum. It risks losing subscribers to competing carriers if it forces 2G subscribers to upgrade. However, only around 12% of its postpaid subscribers currently use 2G and the company can look forward to offsetting these losses with the higher data usage revenue that 4G LTE services should bring. In the long run, AT&T would do well to cut out the costs of maintaining a network that is not optimally utilized.
The NextWave Wireless acquisition will give AT&T licenses for Wireless Communication Services (WCS) and Advanced Wireless Services (AWS) bands. The WCS spectrum was auctioned in 1997 but has not yet been used for Internet services because of the possibility of interference with satellite radio services in the adjacent spectrum. But, in June, AT&T filed an application with the satellite radio provider Sirius XM (NASDAQ: SIRI) with the FCC to protect the satellite radio spectrum from any interference from the WCS spectrum. Keep in mind, AT&T is not looking to buy Sirius, nor is it considered a suitor. AT&T is only interested in WCS spectrum for its 4G-LTE Network. Approval is still awaited but AT&T is obviously confident that it will be forthcoming which is why they are going ahead with the acquisition. Other moves in the spectrum space include the acquisition of Horizon Wi-Com and the acquisition of spectrum from Comcast (NASDAQ: CMCSA). Comcast had plans to start its own network, but recently sold a large amount of spectrum to Verizon.
AT&T does not expect to use this additional spectrum, but is making the acquisitions as part of its long-term spectrum strategy. Increasing its broadband capacity is critical for future revenue growth from data usage. Revenues from data usage have already grown from $5.4 billion to $6.4 billion in the space of one year and looks set to overtake revenues from mobile phones within the next year or two.
One notable result of second quarter operations was the increase in operating margin from just under 27% to over 30%. This enabled the wireless segment to improve its EBITDA margin by nearly 4% to 45%. I believe that this increased margin is sustainable in the long-term because of the increase in smartphone usage, which grew from around 50% of its postpaid customers to almost 62%, and this number should grow considerably when the new iPhone 5 is released in September. The increased availability of spectrum will also support this growth, and the string of small acquisitions means that AT&T can avoid problems relating to competition issues.
I urge investors to consider AT&T as an income investment alternative to bonds. Its handsome dividend yield of well over 4% makes it an excellent option given the current bond yields. AT&T is not going anywhere for a very long time and there is very little downside here. An investment in AT&T makes a great deal of sense for retirees who need to maximize the income from their investment portfolio. I don't expect great capital appreciation for a while until all the heavy investments in 4G LTE networks and spectrum begin to generate adequate revenues.
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