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>>> AT&T’s Huge Debt Load Isn’t Sinking Shareholders—Yet


By Alexandra Scaggs

Barrons

Aug. 22, 2018


https://www.barrons.com/articles/at-ts-huge-debt-load-isnt-sinking-shareholdersyet-1534963585?mod=yahoobarrons&ru=yahoo&yptr=yahoo



Wells Fargo thinks AT&T (T) is serious about reducing its debt—and that its shareholders could pay the price.


Analyst Jennifer Fritzsche downgraded AT&T’s shares to Market Perform from Outperform on Wednesday, in part because its status as the most-indebted nonfinancial U.S. company could force it to play nice with bondholders at shareholders’ expense.

She also expressed concern about the profitability of its entertainment group, which includes DirecTV, and a slowdown in growth in the part of its business that provides companies with advanced communications services. Shares were down 1.4% at $32.93 at 1:08 p.m..

AT&T certainly has a lot of debt to pay off—more than $180 billion, some $82 billion of which is a result of its acquisition of Time Warner. That means it needs to pay down or refinance $9 billion to $12 billion every year from 2019 to 2024.

Fritzsche and Wells Fargo’s credit analysts believe that means the company must deliver on its previously stated goal to cut leverage to 2.5 times earnings before interest, taxes, depreciation, and amortization (Ebitda) by the end of 2019. Wells Fargo estimates that will require about $30 billion of debt reduction.

“The pendulum has currently shifted in favor of bond holders given the fact one of AT&T leading priorities for cash is debt reduction,” the analysts wrote. “We believe AT&T has to meet its aggressive delevering goal in order to remain in the good graces of bond holders and to preserve future access to debt capital.”

The risk, in Fritzsche’s view, is that the company could give cash to bondholders when it should be investing in programming, capital improvements, and the race to 5G.

We have our doubts about that. Netflix’s (NFLX) second quarter shows that higher spending does not always lead to better results. The platform spends five times more on programming than HBO does, but as of the end of 2017, HBO had 142 million subscribers, while Netflix had 118 million. (Netflix forecasts its subscriber count will reach 135 million during the third quarter.)

Second, AT&T doesn’t seem to have much trouble getting people to buy their bonds, no matter how much debt they have. Last week, its sale of a $3.75 billion five-year floating-rate note, likely the largest in a decade, was met with strong demand, according to Bloomberg. Investment-grade bond managers may want to stay on AT&T’s good side. New bonds are usually issued at a discount to secondary-market prices, so buying into deals can provide a needed boost to returns as rising rates hurt the entire sector’s performance.

And there’s still the question of whether AT&T will actually follow through on its debt-reduction plans. Company treasurers have a patchy history of reducing leverage after deals, even when they say reducing debt burdens is a priority. That’s because shareholders prefer that the companies they own raise financing with debt, rather than diluting their stakes.

There are plenty of examples of companies that have not fulfilled promises to reduce leverage. Five years ago, when Verizon Communications (VZ) announced its megadeal to acquire Vodafone Group’s (VOD) minority stake in Verizon Wireless, the company said it expected to reduce debt and regain its single-A credit rating in “somewhere between four and five years.”

For that, Verizon would need to reduce its net debt to two times Ebitda. Today Verizon’s net debt is 2.4 times Ebitda, according to Bloomberg, essentially unchanged from 2014, the year the deal closed. AT&T’s net debt load is larger, at 3.6 times Ebitda.

The main risk this debt poses to company investors—shareholders and bondholders alike—is that the company’s credit rating gets downgraded below investment grade. Moody’s and S&P Global Ratings currently rate the debt two levels above junk.

For bond investors, a so-called fallen angel with more than $180 billion of debt outstanding would hurt the high-yield bond market as a whole. And shareholders are essentially the last line of defense against such a downgrade: The easiest source of cash in a pinch would be to cut its 50-cent dividend, which it has raised for 34 consecutive years.

Fritzsche and her colleagues do not think the dividend is at risk, however.

“We note no part of this call is our concern about dividend sustainability–we continue to view this as secure,” they wrote.

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