Earnings Preview: AT&T

The second-largest U.S. mobile service provider AT&T Inc. (T) is slated to release its second quarter earnings on July 21 before market opens. The current Zacks Consensus Estimate for the second quarter is 59 cents, representing a decline of 3.07% from the year-ago level.

AT&T had average positive surprises of 4.44% in the past four quarters. But we expect the company to have a tough second quarter due to several reasons.

First, the company is facing strong opposition to its ambitious $39 billion proposed mega-merger with T-Mobile USA, a unit of Deutsche Telekom, announced in late March. We believe the voice of protest from several companies such as Sprint Nextel Corp. (S), MetroPCS Communications Inc. (PCS) and Leap Wireless International Inc. (LEAP) may have an adverse affect on the company’s second quarter profitability.

Second, AT&T lost the exclusive hold it had on Apple Inc.’s (AAPL) iPhone after its largest rival Verizon Communication (VZ) started selling the device in February. The loss of hold on the iPhone may result in loss of new subscribers.

First Quarter Flashback

In the first quarter, AT&T’s adjusted earnings were at par with the Zacks Consensus Estimate and a penny less than the year-ago earnings.

Total revenue improved from the year-ago quarter and surpassed the Zacks Consensus Estimate. Revenues from the Wireless segment reached an all-time high, on the back of record net subscriber addition, connected device additions and higher smartphone sales. Wireline revenue, however, remained the dampener with declining traditional voice access lines.

AT&T added 2 million wireless subscribers to reach 97.5 million. The growth was attributable to the rapid adoption of smartphones, strong prepaid subscribers and growth in connected devices. However, total churn (customer switch) saw just a moderate increase.

On the wireline front, U-verse TV and bundled satellite subscribers remained healthy during the quarter on continued high-speed Internet attach rates. On the other hand, total consumer connections remained depressed due to a drop in traditional voice access lines, partially offset by higher U-verse TV, broadband and VoIP (Voice over Internet Protocol) connections.

Agreement of Analysts

Estimates for the second quarter have been trending downward over the last 7 and 30 days. Over the last 7 days, 2 analysts out of 24 have made downward revisions while one analyst moved in the opposite direction. Over the last 30 days, 3 analysts reduced their estimates while 1 made a positive revision.

For fiscal 2011, out of 28 analysts, 3 revised their estimates downward over the last 30 days while two moved in the same direction over the last 7 days. Only 1 analyst made a positive revision to the estimate over the last 30 days and none revised the estimate upward over the 7 days.

The analysts expect earnings growth to be restricted by regulatory hurdles pertaining to the AT&T/T-Mobile merger. The proposed merger is the largest in the wireless industry and subject to a long regulatory process. The deal will likely face a tough review by the Federal Communications Commission and the Department of Justice. In a cutthroat U.S. wireless industry, the analysts believe the price for wireless services will become more competitive post merger.

Further, the analysts believe AT&T still faces integration problems related to its acquisition of Centennial and the wireless assets from Verizon. The integration of T-Mobile USA, a unit of Deutsche Telekom, might further impede its future growth prospects. Further, competitive pressure, a steep decline in its traditional fixed-line phone business, aggressive pricing plans by rivals and the loss of iPhone exclusivity might negatively affect earnings for the year.

The analysts on the positive side expect the launch of 4G Long-Term Evolution (LTE) wireless network services in summer to provide a boost to the company’s profitability. In addition, AT&T’s billion-dollar investment in cloud computing services will open new opportunities for future growth. Moreover, the company joined hands with a social gaming company, Zynga, to add more value to wireless subscribers.

Magnitude — Consensus Estimate Trend

Over the last 7 and 30 days, the magnitude of the second quarter estimate revisions remained unchanged at 59 cents.

For fiscal 2011, the Zacks Consensus Estimate remained static at $2.53 over the last 7 and 30 days.

Our Analysis

Although the AT&T/T-Mobile merger would lead to extensive growth in subscribers, revenues as well as profits, it is a time-taking process and might alter the structure of the overall telecommunication industry. We believe the inclusion of T-Mobile operations will position AT&T as the market leader in the U.S. wireless industry and further bolster its mobile broadband services, which are currently booming.

Additionally, the company is expanding its wireless and wireline businesses, which would in turn fuel profitability going forward. However, the completion of the T-Mobile and AT&T deal contains a number of risks.

We are currently maintaining our long-term Neutral rating. The stock retains a Zacks #3 (Hold) Rank for the short term.

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