AT&T; Jolted by Heavy Cost of Boosting Share in High-Tech Markets

The small investors who hold most of American Telephone & Telegraph Co.’s stock are by now used to a disclaimer that seems to pop up each time the company issues a new earnings report. The recurrent phrase says, in effect, that while AT&T; is moving ever closer to a brave technological tomorrow, shareholders must be prepared to endure a few more bumps and jolts on the way.

The phrase appeared again last week as the telephone giant reported its 1985 financial results and sent stock analysts and investors again groping to discover why the company’s earnings failed to meet general expectations.

What they found were new signs that the company is struggling with mounting losses in its equipment-sales divisions as it seeks to market the business telephone equipment and computers that it needs to guarantee a prominent role in tomorrow’s high-tech markets.

While the company has long acknowledged difficulty in these efforts, AT&T;’s problems were exacerbated in 1985 by a slowdown in the computer industry and a price-cutting free-for-all among the makers of telephone switching gear used by local telephone companies and other general businesses.

To the consternation of many observers, the expenses associated with these equipment-sales efforts seem to be absorbing much of what AT&T; recently has saved through a cost-cutting drive that has included the layoffs of thousands of employees.

Earnings Decline in Quarter

“The company has laid off 24,000 and reorganized to cut, maybe, $1 billion a year in costs. Where is all that money going?” asks Harry K. Rosenthal, analyst with Bear, Stearns & Co. in New York. “The question is, how much longer do they have to keep throwing money around to gain themselves market share?”

The company’s earnings have disappointed analysts in seven of the eight reporting periods since divestiture created a new AT&T; on Jan. 1, 1984, Rosenthal said.

For all of 1985, the company reported an increase in net income of 13.6% to $1.56 billion on revenue of $34.9 billion. But the fourth-quarter results were strictly bad news--a 1.6% earnings decline to net income of $364 million.

The figure was about one-third lower than most analysts had predicted, and AT&T;’s stock slid from $23 before the Tuesday earnings announcement to $21.375 at the close of trading Friday.

AT&T; officials, while acknowledging that results were below expectations, insist that they had never given Wall Street cause to think the earnings would be higher. “We’ve said we had a long way to go to rebuild after divestiture, but we haven’t made any predictions,” company spokesman Dick Gray said.

The company also declines to say anything about earnings or sales of specific product lines outside AT&T;’s regulated long-distance telephone business.

Analysts say, however, that despite increasing competition from MCI Communications and other companies, AT&T; increased the revenue and profitability of its long-distance service in 1985.

Analysts estimate that revenue rose 6% and profits grew more than 10%, helped by cost cutting and new telephone service features that were offered to business users. Revenue from AT&T;’s long-distance unit account for about 45% of the total.

Equipment Traded In

Other parts of the business offer less reason for cheer. Increasingly, AT&T; customers have tried to save money by trading in their rented equipment to purchase the hardware. They have traded in not only residential telephones but also the smaller office-telephone systems called key systems, larger office switchboards and a range of other kinds of equipment.

Lately, this trend has accelerated. Last year, rental revenue declined 19.8% from the $7.2 billion reported in 1984, AT&T; said.

“That really hurts, when you consider that the gross profit on the rentals can be 60% of revenues,” said Glenn Powers, an analyst with Northern Business Information Inc. in New York.

But worst of all may be the mounting cost of AT&T;’s efforts to market its equipment, which some analysts say may be draining the company of as much as $1 billion a year.

AT&T; has mounted a formidable effort to sell its private branch exchanges (PBXs), switchboards that typically carry up to 200 lines of voice and data transmissions. The switching systems, which cost up to $3 million, are considered of strategic importance because they can act as the hub of the highly computerized “office of the future.”

The theory behind the strategy is that the company that sells PBXs also will be able to sell the same customers a variety of other, compatible telecommunications and computer hardware and software.

Deep Price Cuts

Northern Business Information estimates that AT&T; held more than 24% of the PBX market last year, up from 19.6% in 1984. The company gained that share, however, by deeply cutting the prices of its two models, the System 75 and larger System 85.

While suppliers typically bid prices of $600 per line for such a switchboard, AT&T; has bid as low as $450 a line for some larger systems, researcher Powers said. “That’s 25% below the typical price, and you can imagine what that does to your bottom line,” he said.

David Rendall, former vice president of strategic planning for AT&T; competitor Northern Telecom Ltd., says AT&T; was jolted out of a complacency in the PBX market as well as the market for so-called central office switchboards--large systems (up to 50,000 lines) that are purchased by local telephone companies.

“All their rhetoric was about gaining share in new markets until they realized they were about to be squeezed out in their core businesses, like central office switches,” says Rendall, who is now president of RP TeleTrends, a telecommunications research firm in Research Triangle Park, N.C. “They’ve had to throw a lot of money into stopping that market-share erosion.”

Regained Market Share

Researcher Powers contends that AT&T; regained a substantial slice of market share last year in central office switches, reversing the gains made by Northern Telecom. AT&T; simultaneously cut its costs of manufacturing the big switchboards and last year again began turning a profit on the operations, he said.

AT&T; is still far from breaking even on its minicomputers and personal computers, Powers said, but he estimated that the computer line accounts for only about $1 billion of the company’s annual revenue.

Further Cost Cutting Seen

Some observers expect AT&T; to undertake further cost-cutting steps in 1986, perhaps particularly in AT&T; Information Systems, the computer and office telephone arm. AT&T; announced Aug. 21 that it would lay off 24,000 of the unit’s employees.

On April 1, AT&T; will begin contract negotiations with its labor unions, and some expect the company to ask for concessions that would bring AT&T; manufacturing and marketing costs in line with those of its competitors. The current contract expires May 1.

Some analysts doubt that those talks will do enough and predict further layoffs, despite Chairman Charles L. Brown’s pledge that no major cuts will be made through the next three quarters.

“The problems are still on the cost side, so I think you’ll see a substantial head-count reduction this year,” said Alice Bradie, an analyst with E. F. Hutton.

AT&T; GAINS IN P.B.X. MARKET

Market share, in percent

1984 1985 AT&T; 19.6% 24.2% Northern 19.5 22.1 Telecom Rolm 14.3 16.2 Mitel 9.6 10.3 Others 37.0 27.0*

*Does not total 100% because of rounding

Source: Northern Business Information Inc.