AT&T Has $34 Fair Value As Data Revenue And Margins Recovery Kick In

AT&T (NYSE:T) announced its Q1 2012 results Monday. As expected, smartphone sales saw a seasonal slowdown following the record smartphone sales posted in the December quarter. That did not matter much for AT&T, however, as its data revenues grew unabated and wireless margins recovered from the smartphone subsidy shock last quarter. But it did have a negative impact on postpaid subscriber additions, which came in at a modest 187,000 net adds compared to the 776,000 added last quarter. Increasing competition from rivals Verizon (NYSE:VZ) and Sprint (NYSE:S) in an increasingly saturated wireless market is causing subscriber growth to slow down, and the availability (or not) of LTE in certain markets could be key to attracting new subscribers as well as retaining old ones from hereon.

We maintain our $34 price estimate for AT&T, about 7% ahead of the market price.

See our complete analysis for AT&T stock here

Margin Recovery; ARPU rises

After the frenetic holiday buying seen last quarter, which helped AT&T post its best quarter ever in terms of smartphone sales, we could see a seasonal slowdown in smartphone sales in the March quarter. AT&T sold ‘only’ 5.5 million smartphones this quarter compared to 9.4 million that it had sold in the last quarter of 2011. iPhone continued to dominate sales at the carrier, accounting for almost 80% of the total smartphone sales at the carrier.

The seasonal slowdown in smartphone sales helped wireless margins rebound during the quarter. The company’s operating margins recovered more than 1200 basis points (12%) over the previous quarter, when smartphone subsidies had nearly cut its margins in half. This may however not last as the need to promote LTE more kicks in, and AT&T starts providing higher subsidies on LTE smartphones in order to spur demand in the yet nascent technology.

Bolstered by increasing smartphone penetration, AT&T’s postpaid data ARPU levels continued to rise strongly as smartphone users are usually heavy data users as well. AT&T said that about 78% of all postpaid device sales this quarter were smartphones. This helped increase its smartphone penetration within the postpaid subscriber base to 59.3% from 56.8% at the end of the fourth quarter 2011. As a result, AT&T’s data revenues soared almost 20% and postpaid data ARPU grew 15.7% over the same period last year.

Modest postpaid subscriber gains

The U.S. wireless market recently reached saturation, with the number of wireless connections exceeding the population in the first half of 2011. ^[1] This is making it tougher for AT&T and other carriers to attract new subscribers, especially those that pay for the higher-margin data plans. AT&T gained a net 726,000 wireless subscribers during the quarter, less than a third of the number added in the same period last year. Of that number, only a mere 187,000 were contract-based postpaid subscribers.

Many of these net adds were brought in by the launch of the new iPad in March. AT&T said that it had added 240,000 tablet users during the quarter, 75% of which were postpaid. Subscribers on data-only plans such as those on tablets pay much lesser than smartphone users do per month. A data-only plan on a tablet costs around $15-$50 per month whereas an average smartphone customer pays upwards of $80 every month.

With wireless penetration crossing the 100% saturation mark, most of the growth in the coming years could come from data-centric devices such as tablets and e-readers. While average overall ARPU levels might drop, margins will improve as these plans generally have higher margins than smartphone plans.

An intensely competitive and saturated wireless market also makes it essential for AT&T to expand its LTE network into as many markets as possible, as LTE could increasingly become one of the key reasons why subscribers switch/choose one carrier over another. Currently, its LTE network lags much behind Verizon’s, which covers almost thrice as many Americans as AT&T’s does. However, AT&T can look to leverage its more widely deployed high-speed HSPA+ network to make up for that lag in the near-term.

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1. CTIA Semi-Annual Survey Reveals Historical Wireless trend, October 11th, 2011 [↩]