AT&T's Cash Cow Is Changing

AT&T (T), as one of the largest telecommunications companies in the world, is a large and complicated enterprise. It has multiple operating segments, some of which have multiple sub-segments, which make up the enterprise, and each of these are important to the firm, its future prospects, and its shareholders. When you really drill down deep into the business though, while it really is an aggregation of smaller (but still very large) firms, the core of what makes AT&T the behemoth it is today is also its largest cash cow: Mobility. In recent years, growth there has been essentially non-existent, but that’s only at face value. When you consider the paradigm shift taking place in the industry, it becomes clear that growth for the business should resume, but it will take a little time.

Mobility is significant

Mobility is, in the simplest terms I can conjure, AT&T’s sub-segment listed under its Communications segment that offers customers across the US with wireless services and related equipment. If you envision AT&T as primarily a cellphone and cellphone services provider, then Mobility is precisely what you’re thinking of and your thought process would be correct. While Communications as a whole would make for an interesting discussion, though, my primary emphasis in this piece is to discuss Mobility specifically.

Over the past few years, anybody looking at Mobility’s revenue would be certainly underwhelmed. Sales back in 2016 came in at $72.59 billion. They dropped modestly to $71.09 billion in 2017 before ticking up to $71.34 billion last year. Though technically down over this three-year period, the extent of the decline is such that it’s about the same as saying sales are essentially flat.

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What’s really interesting about these revenue figures is how they break down on a service vs. equipment basis. Service sales have dropped materially since 2016, declining from $59.15 billion then to $54.93 billion today. Equipment sales have mostly made up for this, soaring from $13.44 billion to $16.41 billion. Though this may seem odd, I’ll explain later in this article why this likely is.

On the bottom line, things are going quite well for AT&T’s Mobility operations. Segment profits have actually ticked up, rising from $20.74 billion in 2016 to $21.72 billion last year. On a margin basis, this translates to improvement over time, with the segment profit margin climbing from 28.6% in 2016 to 30.4% as of last year. What’s really remarkable about Mobility is the fact that, despite it accounting for just 41.2% of the company’s overall revenue during 2018, it accounted for an impressive 56.3% of the business’s segment profits and for 67.3% of AT&T’s Communications segment’s profits. Given how integral this is to the business, there’s no doubt in my mind that you can consider Mobility to be a cash cow.

The picture is distorted

Sometimes when you look at a company’s financials, the first glance gives a great view of how things really are going, while other times the picture is distorted. AT&T is a case of the latter. If you looked solely at sales, and even segment profits, you would think the business has stagnated and that, perhaps, the future will be worse (or at least no better) than the past. This thought might be strengthened, even, for investors who look at AT&T’s wireless subscriber count and see that from 2016 to 2018 it fell from 77.37 million accounts to 76.89 million.

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When you really dig deep, though, you see that the composition of these wireless subscribers is looking favorable for the company long-term. Between 2016 and 2017, for instance, the business saw the number of postpaid smartphone subscribers rise 2.7% from 59.10 million to 60.71 million. Its postpaid feature phone subscribers, meanwhile, were responsible for the decline, falling 11.5% from 18.28 million to 16.18 million. The difference between smartphone and feature phone subscribers is that the latter are those customers who own a cheaper phone, one with limited functionality but that comes at a budget price point. What this trend indicates is that more and more consumers are shifting toward the premium smartphone market and away from cheaper alternatives.

In the past, I have written about the Connected Devices operations within the Mobility sub-segment and those too are undeniably helpful for the firm’s operations, both now and for the future. Because I have dug into that area before, though, I will not rehash those details here, but will refer you to my latest article on the topic. Outside of Connected Devices and postpaid smartphones, however, another hot market for AT&T is the prepaid side. The company’s subscriber count there grew much higher between 2016 and 2018, climbing 25.6% from 13.54 million to 17 million. Should this trend continue as well, it will help to offset the decline in prepaid feature phone subscribers.

This brings me back now to the company’s service revenue vs. its equipment revenue. Equipment revenue is rising for two reasons. The first, according to management, was a change in accounting principles that affected how it recognizes sales from bundled contracts, and the second was due to the sale of higher prices. As fewer featured phone subscribers exist and shift more toward smartphones, a trend that is simply inevitable, this should continue. On the service side, the firm benefited from higher prepaid service revenues, but what more than offset these sales increases were shifts toward more unlimited plans by customers, combined with an accounting policy change that affected the picture in a negative way for Mobility to the tune of $1.74 billion in 2018 compared to 2017.

Takeaway

Right now, the picture facing AT&T’s Mobility operations is complex and multi-faceted, but contrary to potential concerns that the company’s core business, its cash cow if you will, is doing poorly, we have data that suggests that the issues in recent years can be chalked up largely to one-time changes and a shift of consumers to unlimited plans and away from low-priced phones and toward higher-priced ones. As postpaid feature customers wind down, negative pressure on Mobility’s sales will ease and the sub-segment should benefit not only from its higher-margin activities, but also from the new sales mix that will lead it into the future. For long-term investors, this looks set to create a bullish scenario for the firm, but it will require a great deal of patience and a true long-term mindset.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.