Image Shown: Shares of AT&T moved higher on September 9 after hedge fund manager Elliott Management, run by multibillionaire activist investor Paul Singer, disclosed a $3.2 billion stake in the firm. The hedge fund has big plans for AT&T and is pushing for changes at the telecommunications, media, and entertainment company.
By Callum Turcan
High Yield Dividend Newsletter holding AT&T (T) was back in the news this Monday (September 9) as activist investor Paul Singer, founder of Elliott Management, announced that the hedge fund manager had acquired a $3.2 billion stake in the company. Through a four-point plan, dubbed “the Activating AT&T Plan” according to the letter Elliott Management sent AT&T pushing for change, Elliot Management thinks shares of T could hit $60/share by 2021. Our fair value estimate stands at $38/share for AT&T, a bit above where shares were trading at after the market closed on September 9. Shares of T yield 5.5% as of this writing.
Part of Elliott Management’s strategy involves AT&T formally committing to allocating half of the firm’s post-dividend free cash flows to debt reduction and half to share buybacks. Deleveraging and taking advantage of AT&T’s undervalued equity would help AT&T better converge towards our estimate of its intrinsic value while generating shareholder value in the process (in Elliott Management’s view). The high end of our fair value estimate range is in the mid-$40s.
AT&T’s net debt load stood at $171.3 billion at the end of 2018 (total debt of $176.5 billion less $5.2 billion in cash and cash equivalents) after the firm acquired DirectTV in 2015 and Timer Warner in 2018. Deleveraging efforts through the first half of this year shaved AT&T’s net debt load down to ~$162.1 billion by the end of June 2019, represented by $8.4 billion in cash and cash equivalents less $170.6 billion in total debt.
In 2018, AT&T generated $22.4 billion in free cash flows while spending $13.4 billion on its dividend payments. Furthermore, AT&T’s free cash flows have averaged $18.3 billion over the past three full fiscal years. Management expects AT&T will generate ~$28.0 in free cash flows in 2019, guidance which was raised during the company’s second-quarter 2019 earnings report by $2.0 billion. That should allow for meaningful deleveraging activities going forward, and we really like the guidance raise.
We caution that AT&T’s enormous debt burden, while very manageable given its strong free cash flow profile, represents the biggest threat to its growth trajectory and dividend payouts. By bringing this burden down, we think AT&T could unlock a lot of shareholder value (by reducing financial risk) and Elliot Management seems to be pushing management to do just that. We would prefer AT&T allocate more towards debt reduction instead of share buybacks. Management indicated that AT&T was going to begin buying back a meaningful amount of its stock in the medium-term during the firm’s second quarter 2019 conference call with investors, indicating deleveraging activities may slow down to make room for share repurchases.
One of the benchmarks Elliott Management has laid out is for AT&T to bring its leverage ratio down below 2.0x by 2022. By the end of 2019, AT&T’s management is aiming for the company’s leverage ratio to hit 2.5x (defined as net debt to adjusted EBITDA). The company could pursue additional divestments to enhance its current deleveraging strategy.
Elliott Management also thinks that by following the hedge fund’s four-point plan and other recommendations, AT&T could save $5.0 billion a year by reducing its SG&A expenses (Elliott Management thinks the company’s administrative operations are very bloated), outsourcing non-core functions, rationalizing its spending on procurement, and consolidating its facilities. That’s an intriguing proposition, but one that might prove overly optimistic.
It’s clear that Elliott Management doesn’t agree with AT&T’s approach to M&A as well as its media-and-entertainment strategy going forward (using its purchase of Time Warner to launch its own streaming service that competes with Netflix (NFLX), Walt Disney Company (DIS), and other giants). AT&T has reportedly hired Goldman Sachs (GS) to fight off Elliott Management’s push for change. Either way, AT&T is beginning to converge towards our fair value estimate and continues to represent a great way to generate meaningful income in a low interest rate environment.
Telecom Services: BCE, CTL, EQIX, FTR, S, T, TMUS, VOD, VZ
—–
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Callum Turcan does not own shares in any of the securities mentioned above. AT&T Inc (T) is included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.