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Proactive debt management should flatten AT&T curve

| October 23, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

While AT&T Corporation (T, Baa2/BBB/A-) reported solid third quarter results underscored by better than expected wireless subscriber growth, the company’s proactive approach to managing the balance sheet this year has been the real highlight for the credit. Since the first quarter of 2020, T has reduced or extended over $30 billion in near term maturities, thereby smoothing its debt towers and reducing overall leverage. Despite a lackluster equity performance, further debt reduction remains management’s number one capital allocation priority, which could lead to a flattening of the 10s/30s part of AT&T’s debt curve relative to peer Verizon.

T has reduced debt maturities by over 50% for the next five years and has reduced its average coupon rate to just below 4.1% (from 4.3%) while extending its weighted average maturity by four years, to 17 years. Net debt now stands at $149 billion, which is down from $180 billion since the close of the Time Warner acquisition. That said, leverage at 2.66x is close to management’s target of 2.5x. While the company had briefly hit their leverage target at the end of last year, the reduction in EBITDA driven by the pandemic pushed leverage roughly over a tick higher. Management believes that creating a strong balance sheet and consistent results will translate to better equity performance than increasing share buybacks.

Exhibit 1: T 2020-2025 Debt Towers 3Q20 vs. 1Q20 ($ in billions)

Source: AT&T earnings presentation, Amherst Pierpont Securities

AT&T’s debt curve is plotted against the BBB communications curve and Verizon’s (VZ – Baa1 (p)/BBB+ (p)/A-) curve (Exhibit 2) to compare the relative steepness of the 10s/30s sector. While the spread differential between T and VZ is closer to 50 bp in the 10-year part of the curve, it is over 80 bp in the 30-year part of the curve. Additionally, the relationship between the two credits in 30-year CDS is approximately 47 bp. This would indicate that that T’s curve is too steep relative to its higher rated peer and investors could expect the curve to flatten as T continues to prioritize debt reduction. Lastly, T traded only 50 bp behind VZ in the 30-year part of the curve this time last year.

Exhibit 2. T Curve vs. VZ & BBB Communications Curves

Source: Bloomberg/TRACE indications, Amherst Pierpont Securities

Further Asset Sales to Come – DirecTV?

While T is expecting $3 billion of previously announced asset sales to close before year–end, including disposition of its CME assets which closed last week, management is exploring the possibility of further asset sales.  As noted on its earnings call, with over $500 billion of assets on the balance sheet, it gives T ample opportunity to continue to strengthen its balance sheet and cash position by monetizing non-core assets. That begs the question, is DirecTV on the chopping block?

Elliot Management Corporation disclosed that it had taken a $3.2 billion stake in T last year. Since then, its position has increased to $5 billion. At the time of taking its initial position, Elliot Investment Management questioned some of T’s acquisitions (including DirecTV) and challenged them to rethink its strategic rationale behind holding on to certain assets that they deem non-core. Elliot Management’s view is that bigger is not always necessarily better, thereby making T an “outlier” in the communications sector as it continues to make large acquisitions. Additionally it was rumored in early September that T was in talks with private equity firms over a potential sale of the unit. A sale to private equity might be the most likely outcome as it could circumvent any type of regulatory concerns.

A sale of DirecTV would be a positive for T bondholders as the asset is so large that a sale would require further significant debt reduction. This would accelerate T’s debt reduction plans and help the company to achieve its longer term leverage target of 2.0x (expected to be achieved by 2022), and it would enable T to shed an underperforming asset. DirecTV has been witnessing subscriber declines given the rise of streaming services such as Netflix, which has prompted the growing “cord cutting” movement. T purchased DirecTV at the height of satellite, and while it witnessed some subscriber growth at the unit post close from July 2015 through the end of 2016, DirecTV has posted subscriber losses since.

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