Skip to main content

DLJ Analyst Warns: Steer Clear of AT & T

New York-Donaldson Lufkin & Jenrette tele-communications analyst Richard Klugman painted a gloomy picture for AT & T Corp., a stock that has been battered for most of this year as Wall Street struggles to determine a proper valuation for its cable and telecommunications assets.

In a panel discussion at last week's PriceWaterhouseCoopers 2000 Global Entertainment, Media & Communications Summit conference here, Klugman singled out AT & T as the stock to avoid.

AT & T's stock has been under intense pressure this year. It lost about 47 percent of its value since December amid doubts that the company can execute its broadband strategy while maintaining its core long-distance and business-telephony enterprises.

"The one I would steer away from is AT & T," Klugman said. "It's going to get worse before it gets better. The problem is it [the stock] is cheap and it's built to stay that way."

Klugman stopped short of calling AT & T's cable strategy a mistake-he said the jury was still out on that-but added that the telecommunications giant must rectify several other problems before it can return to its lofty values of last year.

In March, AT & T stock had traded as high as $60.31 per share. It closed last Tuesday at $30.94 each, down 75 cents apiece.

Klugman said AT & T had little choice but to buy into cable-it spent about $100 billion on its acquisitions of Tele-Communications Inc. and MediaOne Group Inc.-and said the faster-than-expected decline of its long-distance business was the main culprit for the stock slide.

And AT & T isn't likely to solve that problem by merging with British Telecom plc or combining its wireless business with cellular giant Nextel Communications, as reports have suggested, Klugman said.

"BT makes little to no sense," Klugman said. "I can't see anything they could do with BT that would help them out of their issues in the [United States]. Nextel could be a little interesting.

"Wireless M & A [mergers-and-acquisitions] activity has been geographic, combining to have a wider footprint," he added. "That makes some sense. This one I'm not sure makes a lot of sense unless AT & T feels Nextel gets them more into the business community."

Klugman also offered faint praise to AT & T chairman C. Michael Armstrong.

"Armstrong has done a great job of pushing people in a direction," Klugman. "Part of the problem is he's been moving in so many directions-with the wireless IPO, with cost cutting, with the cable side-that a lot of important things, like running business long-distance and having a sales force that is incented with the right commission structure, have fallen by the wayside."

After the panel, Klugman said he expects AT & T to make some kind of move, though not an overly dramatic one, as a result of its highly publicized annual strategy meeting slated to start last Thursday.

"Armstrong is not a man of inaction," Klugman said. "He doesn't want to wait around for Wall Street to figure out what the business is worth."

AT & T notwithstanding, other analysts on the panel said uncertainty about the ultimate success of cable's voice, video and data-bundling strategy has led to lower valuations.

In the past, said PaineWebber Inc. analyst Christopher Dixon, cable was valued using one of two models: a licensing model, in which the operator licensed various distribution streams, or a gatekeeper model, under which the operator charged a toll for allowing content to move through its communications pipes.

"What used to be just voice or just video has now moved to bits and bytes," Dixon said. "The issue now is, if it's voice [moving through the pipe] it's one value, if it's video it's another value, and if it's data it's another."

That shift has caused a fair amount of uncertainty and has forced cable-stock analysts to use terminal-valuation methods, which are based on perpetual growth rates and the expected return.

"What's happening now is that the expected return and growth rates are beginning to diverge," Dixon said. "Investors are saying we need to supply a higher return and we're less certain of the growth rates we saw before. That net result means multiples are coming down."

Cable companies that have learned to set themselves apart are the ones that will win in the end, said Sanford Bernstein & Co. Inc. analyst Tom Wolzien.

The addition of telephony service, which is basically a commodity, will not make the difference, he added. Programming will.

He cited Comcast Corp., which offers local sports programming in the Philadelphia regional market that isn't available elsewhere.

Wolzien also was bullish on the proposed merger between America Online Inc. and Time Warner Inc. There is tremendous potential in combining Time Warner's advertising strength with AOL's Internet presence, he said.

He also praised The Walt Disney Co., which will be a powerful stock once Disney "figures out how to make its Web [strategy] work," he said.

Dixon also liked AOL Time Warner and Disney, saying that Disney's Internet unit has faltered but is on the road to recovery.

"Disney Internet Group has absolutely done a terrible job, but they are on the way to getting it right," Dixon said, adding that his hopes for Viacom Inc.'s stock are also high.

On the downside, Wolzien said Cox Communications Inc., which has faltered because it missed its second-quarter cash flow numbers, continues to be a concern.

Dixon also expressed some concern about Vivendi S.A., which is in the middle of a $34 billion merger with The Seagram Co. Ltd.

"Vivendi's valuation over the longer term is attractive," Dixon said. "But they've done a very poor job in articulating what their strategy is."

Klugman said his favorite stocks include Qwest Communications Inc., which he believes has a significant revenue upside, and 360 Networks Inc., which is headed by former Microsoft Corp. chief financial officer Greg Maffei.