AT&T’s Rising Wireless Capital Spending Could Hurt Stock

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In its most recent earnings report, U.S. telecom giant AT&T (NYSE:T) reported a sharp increase in its spending on wireless network technology.  AT&T competes primarily with Verizon (NYSE:VZ) and Sprint (NYSE:S) in the wireless business.

AT&T’s wireless capital spending grew by nearly 50% in the second quarter of 2010 compared to the year-ago quarter. While this spending obviously hurts AT&T’s cash flow, it has also delivered significant subscriber benefits, including faster download speeds, fewer blocked calls and reduced call drop rates. We also note that AT&T’s average monthly revenue  per per user and IP data revenue from businesses both increased in the second quarter.

Based on these trends we are maintaining our $37.91 price estimate for AT&T’s stock, which is based in part on the assumption that wireless capital spending will increase at a steady annual rate of 6% during the Trefis forecast period.  In the event that wireless spending grows at an annual rate of 10%, however, we see a potential 6% to 7% downside for the stock. Our analysis follows below.

Wireless initiatives drive spending growth

Much of AT&T’s wireless capital spending has been devoted to improving its 3G network. The company has bought additional spectrum, deployed improved High Speed Packet Access (HSPA) software and added fiber backhaul, which carries data to wireless distribution points.

AT&T reports that 3G download speeds on its network are up by 15% compared to a year ago. Download speeds are up 32% to 47% in areas where fiber backhaul and HSPA 7.2 software are in place.

Going forward we expect AT&T’s capital spending to shift increasingly from wireline to wireless. We expect 2010 wireless capital spending to grow by 30% year-on-year, to nearly $7.5 billion. By the end of 2010, we expect wireless to account for about 40% of AT&T’s total capital expenditures, up from 34% in 2009.  Meanwhile, we expect wireline capital expenditure to decline slightly this year, to $10.9 billion.

Going forward, wireless capital spending will continue to be driven by network improvement initiatives. AT&T intends to launch an HSPA+ upgrade by the  end of 2010. In 2011 it plans to roll out Long Term Evolution (LTE), a new, high-performance interface for wireless communication. In the chart below you can drag the trend-line to create your own forecast for AT&T’s wireless capital expenditure as a percentage of gross wireless profits.

On the contrary, we expect wireline capex decline to continue. AT&T has been investing in the roll-out of its land-based U-Verse service. But capital spending on U-Verse is expected to slow in 2011, when the company expects to complete its initial roll-out to 30 million homes.

While we expect wireline spending to decline in absolute terms, we forecast a slight increase in wireline capital expenditure as a percentage of gross wireline profits, due to declining gross profits in the wireline business. You can drag the trend-line in the chart below to create your own wireline spending forecast and see how it impacts AT&T’s stock price.

Rising wireless spending could hurt AT&T’s stock

We don’t expect declining wireline capital expenditure to offset rising wireless capital spending. AT&T is improving its wireless network in order to grow its subscriber base. The company hopes that a better network will yield incremental revenue by attracting more smartphone and other connected device users who will buy high-end data plans.  But the increased capital spending could still put negative pressure on the company’s stock.

Currently we forecast an average growth rate of about 6% in wireless capital expenditure for next 3-4 years. If this growth rate increases to 10%, we would expect a 6% to 7% downside to our $37.91 estimate for AT&T’s share value.

You can see the complete $37.91 Trefis price estimate for AT&T’s stock here.

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