A Prudential report issued 4/27/99
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EQUITY RESEARCH
AT&T CORP.
APRIL 27, 1999
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AT&T BEATS EARNINGS EXPECTATIONS; REVENUE GROWTH ACCELERATING; WIRELESS, BUSINESS SERVICES AND SOLUTIONS ALL AT OR ABOVE PLAN; STRONG BUY/SELECT.
Subject: AT&T Corp. (T-52 15/16)--NYSE TELECM
Highlights:* AT&T beat our first quarter EPS expectations. EPS was $0.61 versus our $0.57 estimate. Excluding the impact of the TCI acquisition, EPS was $0.67. * We are maintaining our estimates, but believe there may be some upside to our annual number based on better than expected revenue growth. * Revenue growth of 6.2% (pro forma) exceeded our expectations with strength seen in wireless services, data services, and AT&T Solutions. * We believe this quarter's results represent the continued building of revenue growth from the less than 1% growth reported in the first quarter of 1998. We expect revenue growth to continue to ramp through this year and over the next several years, leading to a change in investor perception towards AT&T to a high quality, large cap growth company. With the strongest brand in one of the premier growth industries, AT&T should be able to consistently generate solid revenue growth (10%-12% including MediaOne, 8%-9% excluding MediaOne) and leverage that into mid-to-high teens cash flow growth. Investment OpinionAT&T is rated Strong Buy/Select List with a target price of $71. Based on our sum of the parts valuation analysis, though with the acquisition of UMG, our $71 target would represent the high end of our valuation range rather than the middle of the range. Over time, however, the faster growing parts of AT&T's business should grow to represent a larger piece of the overall company, leading to an expansion in the multiple the market awards the consolidated company. Thus, we believe AT&T has successfully transformed itself into a company that the market will come to view as more of a growth story than a cost reduction story. Additional InformationFirst Quarter Earnings Show Progress Towards Goal Of Becoming World Class Growth Company. To be sure, AT&T still faces significant challenges in implementing its consumer local strategy and in fending off the Bell companies when they gain entry into the long distance business. However, we believe AT&T's strategic acquisitions and, maybe even more important, its dramatically improved cost structure put it in a much stronger position today than it was 18 months ago. If successful, AT&T will transform itself from a slow growth, poorly positioned company into a dominant high growth leader in the fast growing telecommunications industry with a strong position in all major communications markets across all customer segments. We believe AT&T will produce an acceleration of both revenue and EBITDA growth and lead to an expansion in the multiples that the market awards the stock. We estimate that the acquisition of MediaOne will increase both revenue and EBITDA growth by 200-300 basis points, with revenue growth increasing to the 10%-12% range and EBITDA growth increasing to the 15%-17% range through 2004. We believe that first quarter earnings show signs of this transformation already taking place. Revenue growth accelerated to 6.1% (excluding TCI), exceeding our 4.0-4.5% expectation. Moreover, revenue growth has accelerated from the less than 1% reported in the first quarter of 1998 and shows no signs of slowing down. Wireless revenue growth was 40% in the quarter, AT&T Solutions revenue increased by 50%, and business services growth was 7.5%. As AT&T adds the cable properties from TCI (and perhaps MediaOne if it wins that acquisition battle), we believe that revenue growth will continue to accelerate from the widespread introduction of local consumer services and expected rapid growth of high speed data services through cable modems. Clearly, AT&T has not yet reached the desired long term growth rates, but we believe first quarter results demonstrated that it is well on its way. AT&T's Normalized First Quarter EPS Was $0.61. Reported EPS was $0.38 which included an in-process R&D write off of $594 million pre tax, a $196 million pre tax charge to exit an international joint venture, a $153 million pre tax gain on the sale of Language Line Services, a $59 million pre tax pension settlement gain, and $57 million negative net income impact from AT&T's stake in @@Home and Cablevision. In total, the net impact from these items was $0.23 per share. We have chosen to pull out the net income impact of @@Home and Cablevision (as has AT&T in its commentary) because the value of these businesses can be readily calculated since each is a public company in its own right. Therefore, the inclusion of what could be significantly dilutive operations (in the equity income line) in our presentation does not help in the analysis of the operating businesses. Revenue Exceeded Expectations. The better than expected earnings can be traced to better than expected revenue growth. Strong performances were recorded by a number of AT&T business units. Overall minute growth was 8.7%, AT&T's best showing since 1997. Business services revenue increased 7.5% with a high teens growth rate for data services, wholesale revenue up over 20% and local switched revenue up over 90%. Wireless revenue increased 40%, driven by 23% subscriber growth and a 15% increase in average revenue per user (ARPU). AT&T added 378,000 new wireless customers in the quarter as Digital One Rate continues to draw customers to AT&T. Since its launch in May 1998, Digital One Rate has added over one million customers. More significantly, over 80% of the new customers in the quarter were new to AT&T. AT&T Solutions revenue increased 50% from a year ago. As expected, consumer services revenue decreased 3.4% from a year ago. Expense Control Continues Strong. Though AT&T beat us on the top line, expenses were pretty much in line with our expectations, meaning the better revenue growth flowed through to the operating income line. SG&A expense was 22.4% of revenue versus 25.5% a year ago and the company looks to be on a path to better the 1999 targets of 21% of revenue in the core business and 23% of revenue overall. Network and other communications services expenses increased 3.6% (excluding the TCI merger), a strong performance given the 6% top line growth. Most of the growth in this line can be traced to the success of Digital One Rate, which led to both higher roaming charges and higher costs for wireless handsets. Depreciation and amortization was higher than we were expecting, principally due to higher plant balances. Network Capital Investments Showing Through In High Data And Wholesale Growth Rates. We believe that AT&T's major capital investment program in its network infrastructure over the past two years has laid the foundation for AT&T to more aggressively pursue growth opportunities. We saw confirmation of that in frame relay growth of 50%, ATM growth in excess of 100% and IP services revenue growth of over 65%. Moreover, AT&T now has the available capacity and flexibility to become a larger player in the wholesale market, with wholesale growth in excess of 20%. Finally, AT&T installed more OC-3 circuits in the first quarter than it did in all of 1998, a testimony to the success of AT&T's network upgrade. Prudential Securities Incorporated (or one of its affiliates) or their officers, directors, analysts, or employees may have positions in securities or commodities referred to herein, and may, as principal or agent, buy and sell such securities or commodities.Prudential Securities Incorporated acts as a specialist that makes a market in the securities of AT&T. At any given time the specialist may have a position, either long or short, in this security, and, as a result of the associated specialist's function as a market maker, such specialist may be on the opposite side of orders executed on the floor of a national securities exchange.Prudential Securities Incorporated and/or its affiliates have managed or comanaged a public offering of securities and/or have performed investment banking or other services for AT&T. Companies mentioned in this report:Media One Group (UMG, 81 1/8, not rated)Cavlevision (CVC, 82 3/8, not rated)
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