The Long and Short

AT&T’s Free Cash Flow Guidance Affirmed

| April 21, 2023

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.

AT&T (T) recently reported fiscal first quarter 2023 earnings with the top line and EPS largely in line with estimates. However, free cash flow of $1.0 billion came in well below street estimates. While management had previously noted that free cash flow would be stronger in the back half of the year, similar to fiscal 2022, the miss dominated the earnings headlines. Absent from the press release was full year guidance, but T reaffirmed its cash flow guidance of $16+ billion on the earnings call. Management also noted that first quarter free cash flow was within their expectations, given their plans for accelerated investments in 5G and fiber coupled with seasonal working capital outflows.

Additionally, management reiterated that it is on track to achieve its net leverage target of 2.5x by early 2025.  T will likely need to conduct a tender offer to hit its leverage target as debt maturities through early 2025 will not fully cover the amount of debt they need to reduce.  T has two maturity walls in 2026 and 2027 that it may look to address. A tender offer would be a catalyst for spread tightening, particularly in in that part of the curve, as well as providing a cash premium for early participation.  Furthermore, T still largely trades wide to Verizon Communications (VZ – Baa1/BBB+/A-) in this part of the curve despite having similar leverage and much stronger subscriber growth.

Exhibit 1. T Curve vs VZ Curve (2yr-6yr)

Source: Bloomberg TRACE; SanCap

Full Year Guidance Reaffirmed

While the press release and corresponding earnings presentation made no mention of guidance, management took time on the earnings call to discuss their expectations for the year.  T noted that the slower macroeconomic backdrop was fully embedded in the full year guidance that they provided in January (Exhibit 2).  While 1Q free cash flow of $1.0 billion was well short of street estimates of roughly $3.0 billion, it was in line with their expectations which accounted for a considerable increase in its 5G and Fiber capital spend, an important long term growth driver for T.  Furthermore, management noted last quarter that 1Q free cash flow would the be “low-water mark” for seasonal reasons.  Fourth quarter is seasonally the largest quarter for device sales given the holiday period.  Payments to vendors for those devices are made in 1Q. Additionally, incentive bonuses are paid in 1Q.

Management is confident in its ability to grow EBITDA this year at 3% or more, which underscores its reaffirmation of full year guidance.  Capital expenditure is expected to be similar to the $19.6 billion spent in 2022. When looking at 2022, T generated approximately 82% of its full year free cash flow in the back half of the year. T expects a similar free cash flow timing pattern this year.

Exhibit 2. AT&T 2023 Financial Guidance

Source: AT&T 4Q22 Earnings Presentation

Debt Reduction a Key Priority

With debt reduction T’s primary focus (after reinvestment in the business) for the next 2 years, we do not anticipate management will look to tap the primary market except to execute short-term leverage neutral capital structure transactions, depending on cash flow timing. T tapped the market in February of this year, bringing a $1.75 billion 3yr issue that was used to repay a maturing term loan.  T has $4.4 billion of debt maturing in 2023, with the majority maturing in 2H23. That said, T is expected to repay that debt as it comes due.

In order to hit its net leverage target of 2.5x, T needs to repay roughly $22.5 billion of debt by early 2025.  Given that T has only $17.5 billion of debt maturing through 2025, the company will likely need to conduct a tender offer to meet its leverage target.  The size of that tender offer will likely be between $5 billion to $7.5 billion, depending on how T plans to address the 2025 debt that matures in the back half of that year.  Furthermore, any shortfall in EBITDA generation will make it necessary for additional debt reduction if T plans to hit its leverage target. The two maturity walls in 2026 and 2027 serve as good tender candidates as it not only helps to address those maturity walls, but the majority of the debt in those years trade below par.  T could also conduct a sweeping waterfall tender, as it has done in the past, to ensure that it has enough participation to meet its debt reduction goals.  Any tender offer would be a catalyst for spread tightening, given the premium to secondary spreads offered coupled with early participation cash incentives.

Exhibit 3. T Debt Maturity Schedule

Source: Bloomberg; SanCap

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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