Gut Check on AT&T: Breaking Up Is Hard to Do Right

While many investors have fled New Economy stocks for the safety of the old, AT&T (T Quote) is one Old Economy standby that is confounding investors more than it is providing relief.

The AT&T File

Current P/E: 13.9

52-week range: $61- $16.50

Change From 52-Week High: - 61.3%

Shares Outstanding: 3.7 billion

Source: Morningstar

After spending $110 billion during the past two years buying cable, wireless and local phone companies to offer bundled services, AT&T did an about-face Oct. 25 when it said it would break into four separate stocks by the end of 2002.

What this means for investors is a question this week's Gut Check put to AT&T watchers, and the answers from mutual fund managers and analysts turned up divided.

Leading to the breakup decision was the news that AT&T's pro forma revenue growth slowed to 4.1% in 2000; the company had been predicting growth in the 8%-9% range. What's more, net income fell 43% from $5.45 billion in 1999 to $3.11 billion in 2000. The final straw came at year-end, when AT&T said it would slash its dividend from 88 cents a share to 15 cents a share. Amid all this, AT&T chairman Michael Armstrong called a senior management retreat in October where the breakup, or project "Grand Slam," was hatched.

Gut Check on AT&T
Pros	Cons
AT&T will break into four separate securities to let its high-growth broadband and wireless divisions shine.	This is a complete reversal of the bundled services approach AT&T chairman Michael Armstrong heralded two years ago.
Some analyses project the breakup value of AT&T being in the $30-$40 per-share range.	Other analysts question how accurate those targets could be because AT&T hasn't released breakup details.
AT&T's wireless business has excellent technology and huge potential.	AT&T has not become the Internet or cable pioneer some thought it should to remain competitive.
Source: Company, fund managers, analysts.

Fund skippers with big stakes in AT&T said they generally applaud the breakup. Rapidly declining revenue in the business and consumer long-distance businesses gave AT&T no choice but to split off its more successful wireless and cable divisions, they say. And the split will bring additional value to AT&T shareholders, they insist, pointing to breakup analyses that project the stock, now trading in the $22 range, being worth $30 or $40 as separate companies. (Today's 10 Questions turned up an AT&T fan in Oakmark Global fund skipper Greg Jackson.)

On the other hand, some skeptics believe AT&T, which is down some 60% from its 52-week high of $61, will remain in the low $20s for the foreseeable future. They also dismiss breakup analyses as being little more than speculative and are skeptical of the move away from bundled services. (Some of AT&T's own workers, who have much of their retirement money in AT&T stock, seem to agree; a major union representing AT&T workers held a press conference last week blasting the plan as ill-conceived).

On the bullish side, managers like Ed Paik of the Liberty Utilities fund are holding on to and even increasing their stakes in AT&T. Paik says he welcomes the opportunity to trade AT&T stock for specialty AT&T wireless and cable securities. Until that happens, Paik expects the stock to hold steady, as long as AT&T's consumer and business divisions continue to meet lowered expectations.

Diane Jaffee, director and senior portfolio manager of the SG Cowen Large Cap Value fund, says she came close to selling her 2.5% position in AT&T the day after the breakup announcement, when the stock fell to $23.38. Though AT&T has not returned to the high $20s where Jaffee bought the stock, she says she's very glad to own the stock because of the future possibilities of its wireless technology. "We think AT&T's wireless unit is superb, that it is going to become the global player," she maintains.

Off-Line The percentage of funds holding AT&T since the beginning of 2000 has fallen
Date	Number of Domestic Equity Funds Owning T	Percent of Domestic Equity Funds Owning T
Jan. 1, 2000	732 out of 2,570	28%
Jan. 1, 2001	604 out of 2,907	21%
Source: Morningstar

Primary Trend's Barry Arnold, who calls himself a "contrarian value-oriented investor," took a 2.56% stake in AT&T late last year precisely because of all the negative reaction to the breakup. While some experts have harped on the $48 billion of debt AT&T still holds, Arnold says they've overlooked the huge investments AT&T holds in AOL Time Warner (AOL Quote), Comcast (CMCSK Quote), Cablevision (CVC Quote) and Microsoft (MSFT Quote) (estimates put these holdings at more than $50 billion). Arnold also believes AT&T Business might be bought by one of its competitors, like Verizon (VZ Quote) or SBC Communications (SBC Quote).

Arnold's own breakup analysis shows AT&T being valued in the $32 range within the next four to six months.

On the side of the bears, though, Jack Grubman, a telecommunications analyst with Salomon Smith Barney, points out that a year ago, these same kinds of breakup analyses valued AT&T in the $60-$70 range. (Salomon Smith Barney has done underwriting for AT&T.) Today, breakup analyses of AT&T have been significantly reduced, primarily due to disappointing numbers in AT&T's long-distance and business divisions, Grubman says.

Last month, AT&T projected business services, which accounts for nearly half its revenue, to be flat in 2001. Long-distance rates are falling faster than the company can predict, and consumers are also increasingly using cell phones for their long-distance calls, analysts note.

As a result, Grubman maintains that continued deterioration of AT&T's long-distance business "will outweigh any sum-of-the-parts exercise until those parts are, in fact, distributed."

Bill Klein, a director at Wasserstein Perella, agrees. "The trouble with the breakup is you don't quite know what you're getting because they haven't fully disclosed" how the IPOs and stock distribution will be handled, Klein says. The split will also create redundant overhead and is counterintuitive to Armstrong's original plan to provide customers --particularly business customers -- with the bundled voice, data and Internet services they want, Klein says

What's known about the breakup plan thus far is that AT&T Wireless(AWE Quote) will be converted from a tracking stock to a fully separate stock, and T will be converted to a stock solely representing AT&T's business division. A separate stock will be created for AT&T's broadband division, and a tracking stock will be created for AT&T's consumer business.

The first stage of the breakup could happen this summer, at which time AT&T investors will be given the opportunity to swap their stock for $10 billion worth of shares of AT&T Wireless. But the company hasn't given any details of how the other stock swaps will be orchestrated and has withheld 2001 earnings and revenue guidance in light of the many details about the breakup that have yet to be determined.

One thing's for certain, though: The breakup of AT&T will have a huge psychological impact. "AT&T will lose its status of being an American icon," says Jeff Kagan, president of Kagan Telecom Associates in Atlanta. But in the end, Kagan believes the breakup will be successful and that even AT&T's core consumer and business divisions will become significant players.

On the Line These funds have made big commitments to AT&T
Fund	Total % of Fund	Date of Portfolio Report
Fidelity Utilities	4.78%	July 31
Liberty Utilities	4.42	Dec. 31
Matthew 25	4.38	Sept. 30
Gabelli Global Growth	4.35	Sept. 30
Firsthand Technology Leaders	4.13	Sept. 30
Source: Morningstar

Hanging it Up These funds sold big stakes in AT&T last year
Fund	Shares Sold	Date of Portfolio Report
Fidelity Growth & Income	1,672,000	July 31
Alliance Growth	1,032,000	Dec. 31
George Putnam Fund of Boston	800,000	Aug. 31
Fidelity Advisor Equity Growth Institutional	664,000	May 31
Scudder Large Company Value	629,000	Sept. 30
Source: Morningstar