AT&T Posts Its Resume

Friday, October 27th, 2017 - Resume

I recently had a vacancy open up in my portfolio. I wasn’t anticipating the vacancy since I rarely sell anything but I was down a cash-flow asset nevertheless. I was happily collecting the nearly 6% yield from Next Era Energy (NEE) junior subordinated debentures, until they were redeemed by the company this month. Since I purchased below par I realized a capital gain (a nice problem to have, but I need to pay Uncle Sam next year on the gain) but I had a bigger problem on my hands: where do I park the money?

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Time to Post a Job Opening

The prerequisites for the opening are fairly straight forward. I want a safe, secure, yield near 5%. I want a lengthy track record of success. I want experience, but I also seek a candidate that can evolve over time and isn’t afraid to venture into new territory. I want the background and credit check to come back without major blemishes. I want dependability. I then posted the job application and started sifting through applications.

The Applicants and Interviews

The First Candidate: Scana

The first application I received came from Scana (SCG). My interest was immediately piqued since it was in the utility industry (my favorite) and yielded over 5%. I decided to move forward with an interview and was optimistic I could fill this vacancy relatively quickly with the first candidate. The resume looked polished, I was impressed. The 10-year dividend track record was impeccable:

Scana also passed the credit check (investment grade), however there were some recent dings when Standard & Poor’s cut the rating from BBB+ to BBB. Fitch also lowered its rating recently as well. That caught my eye and I wondered if there was more to the story. When I asked, Scana was quick to brush over that issue, focusing on recent earnings where it showed impressive growth in GAAP EPS:

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I was further impressed when Scana mentioned that growth was expected to continue at a clip of 4-6% per year while keeping the dividend payout ratio at approximately 60%:

I circled back to the credit ding which was glossed over initially and told Scana that I was going to run a background check. That made Scana squirm in its seat a little bit.

I knew I had some research to do.

I decided to check references like any smart employer and I went straight to the Governor since the utility is heavily regulated by the state of South Carolina. That’s when the fleas began to manifest. Governor McMaster wrote a letter calling on Scana to seize collecting the $37M per month from ratepayers. Scana abandoned the V.C. Summer Nuclear Station and allegedly knew months ahead of time that it would abandon the project despite not notifying investors or the public. Meanwhile the company continued to collect funds granted by the Base Load Review Act. That Act is being challenged in court and the Attorney General is calling for a criminal probe. Needless to say, this was casually left off the résumé. I was glad I did some due diligence since anger is at a fever pitch which leaves Scana uniquely vulnerable to governmental action.

I said farewell and thanks for applying, but I’m gonna pass.

Candidate Number 2: IBM

The next applicant that arrived in my inbox was International Business Machines (IBM). I was initially puzzled since IBM didn’t meet the qualification of 5% dividend yield. But IBM assured me in the cover letter that the lengthy history of rewarding shareholders and a growing dividend would make up for the lack in initial yield. If I held long enough, I would obtain that 5%. I decided it was worthwhile to do some due diligence to see if it deserved the job. Sometimes you have to modify prerequisites so as not to preclude the right candidate.

IBM attached an 11-page paper demonstrating their history of rewarding shareholders with dividends. I was impressed. I went ahead to corroborate the past 10 years which included the Great Recession and found that the rising dividend was as spectacular as advertised:

I could quickly grasp their point when IBM said initial yield will grow if the security is held long term.

I ran a credit check to make sure their ducks were in a row and found that the rating agencies wrote glowing reviews:

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IBM assured me that it was going through some turbulent times and that the ship would right itself in due time. I prodded for more information and they were tight-lipped. I decided that despite the stellar credit rating and the growing dividend and years of experience, something must be causing this ship to slowly capsize…but what?

And that’s when I spotted it, 5+ years of revenue declines. Obviously that was not forthcoming during the interview or disclosed on the CV. I guess we always want to put our best face forward. But there it was for all to see, 5 consecutive years of declines:

That was not a pretty picture, especially since the tax rate has been favorable as of late. I told IBM thanks for applying and I would keep them in mind, but only when the yield breached 4.5% or when revenues began to increase. I told them to call me if that should happen and I would reconsider.

Candidate Number 3: AT&T

I was a bit deflated. I had two candidates come and go and I was no closer to filling the spot. But the third candidate flagged my attention when it led its cover letter with: Change is Coming. I had stipulated that I wanted a company amenable to change. One that was capable of evolving over time. AT&T (T) said that its proposed acquisition of Time Warner (TWX) will usher in a new era where they will own content behemoths like HBO, Warner Brothers, and Turner.

I liked the sound of that quite a bit because I watch a lot of HBO myself, and I am wary of all the cord-cutting and competition coming from smaller players like Sprint (S) and T-Mobile (TMUS) not to mention Verizon (VZ). Plus I was aware that operating income rose 10.4% year over year for HBO and 12.4% for Warner Brothers. Those kind of numbers blew IBM out of the ballpark. They then confidently added that Time Warner’s free cash flow increased by 22%. It appeared this acquisition was truly a wise move.

I told AT&T that a previous candidate had consistently shrinking revenue and that is something I did not want to accept. AT&T provided a copy of its past 10-years of revenues to allay my concerns:

I told them that looks pretty good, but I had heard rumors that the debt load was going to imperil the company. I showed them a chart I found net debt ballooned:

They did not dispute the fact but reiterated that the deal with Time Warner will be accretive after the first year of close and that its credit rating remained investment grade even after accounting for the deal. They also stated that revenues would more than cover the dividend and capex.

When I called the listed references, I realized the expansive geographic footprint AT&T has and needed a translator. AT&T appeared astute at navigating cultural differences and differing political landscapes (like Chile, Mexico, Brazil) obtaining approval for its proposed acquisition from a variety of countries. Although it was still waiting on its domicile of the United States.

I had a lot to think about, and told AT&T we would be in touch.

A day later they phoned to say that if I wanted to fill my opening ASAP, I could do so at a yield of 5.8%. AT&T had just reported earnings and while they missed expectations, the difference was negligible. I asked why they thought the share price was being hammered and they stated the uncertainty with the merger but also highlighted the recent sell-offs in quality REITs like Realty Income (O). They suggested I review the 10-year Treasury note over the last month:

There is a pretty strong correlation when yields rise that bond prices (and securities like T) will fall. That 10% increase in the past month helps justify some of that decline in AT&T’s share price.

Ultimately, I decided that while I was comfortable letting the vacancy sit unfilled for some time, the job could be dependably occupied with AT&T at a share price of $33.70 which wasn’t too far off from the yield I was replacing and is likely to increase with inflation each year.

I decided to add to my stake on 10/25 and the vacancy is now closed.

Disclosure: I am/we are long T, IBM, SCG, VZ, O.

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.

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