AT&T Is a Ringer

AT&T(T) announced Monday that weaker earnings are ahead. Today, Standard & Poor's nicked Telephone's credit rating. So what did the long-beleaguered stock do today? It rallied $1.56 to close at $31.81, of course.

It's easy to hate AT&T. You know the rap. The core long-distance business is rotting on the vine. And who knows if CEO Mike Armstrong's "broadband" strategy -- i.e., upgrading the company's cable systems to handle bundled TV, phone and Internet services -- will generate the hoped-for profits. Even fast-growing AT&T Wireless(AWE), 90% owned by the parent, remains a money-eating business.

And the rap is largely true. Just look at the slide in the stock.

But whether the broadband strategy works or not isn't really the key investing issue here. What you need to pin down is whether the current stock price, which you can see is on its butt, already discounts all the bad news and then some.

Some outstanding investment management firms have recently bought Telephone. (Not that they have made money yet, of course.) The list includes Chieftain Capital, Janus Capital and the Baupost Group. Chieftain came in for 7.9 million shares between March 31 and June 30, according to public filings. Janus bought another 3.2 million shares. And Baupost went bottom-fishing for 2.8 million shares. Noted technology stock mutual fund Firsthand Technology Value bought shares even earlier, added marginally to the position in the second quarter and owned 2.3 million shares as of June 30, according to the filings.

What do they see today? A pile of assets selling considerably below where rational analysis suggests they should. Here's the skinny on why you might want to consider Telephone as a contrary play on the New Economy, based on my conversations with several holders of the stock.

AT&T's ownership in AT&T Wireless is worth about $13 a share using current market prices for the two stocks.

Then you get AT&T's three core businesses -- cable, business services and consumer long distance -- for about $19 a share. $13 + $19 = $32.

What are the core businesses really worth?

Say a cable subscriber would be worth $3,000 to an acquirer. That implies a $13-a-share value for cable.

Business services generate about $30 billion in revenues and $11 billion of earnings before interest, taxes, depreciation and amortization, or EBITDA. Put a fairly conservative eight times EBITDA multiple on the business, which has grown slowly, and you can back into $22 a share of value.

Then there is the consumer long distance biz. It's in decline, and management is mining the business for cash. No big new marketing campaigns. At four times that unit's EBITDA, which assumes a 7% annual decline in the business, you get another $8 a share in value.

Cable ($13) + business services ($22) + consumer long distance ($8) = $43. Add in the $13 a share in AT&T Wireless and you get a value in the mid-50s for AT&T common currently trading at $32.

Then there are AT&T's interests in other publicly traded media and telecom companies. AT&T owns interests in Vodaphone (VOD), Time Warner Entertainment (TWX), Comcast (CMCSA) and Cablevision Systems (CVS). The company carries that collection of publicly traded and private businesses at $48 billion, which probably understates their real value because the shares in the private companies are carried at cost. All that could well offset AT&T's $60 billion of debt. Not bad.

For those who care about earnings and dividends, AT&T pays an 88-cent dividend and will earn about $2.25 a share this year and an estimated $2.40 to $2.45 in 2001.

The key point here is that you don't have to believe in Armstrong's broadband strategy to see value in the stock. With a conservative current business value of $56 a share and the stock trading at $32 a share, any success in broadband or wireless or whatever is gravy.

What's the trigger to realize the value for AT&T shareholders?

Basically, the board. It boasts some smart directors, many of whom have a financial stake in seeing the stock rally. They include cable billionaire John Malone, investment master Lou Simpson of Geico/Berkshire Hathaway and Sandy Weill, chairman of Citigroup and a proven moneymaker for shareholders throughout his long career.

"Given the financial interests and acumen of the AT&T board and Mike Armstrong, we believe they will do what it takes to make the stock price more accurately reflect the value of the company's assets," says Glenn Greenberg, a partner and co-founder of Chieftain Capital.

Armstrong has already telegraphed his desire to engage in some financial engineering. He has said publicly that he would consider an exchange offer of relatively high-priced AT&T Wireless shares for low-priced AT&T shares. Such a move would probably be accretive to AT&T's earnings and might also help investors see the underlying value in Telephone.

You just want to know whether AT&T has bottomed, don't you? All I can say is that it rallied today on ostensibly bad news. That is generally not too bearish.

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