'Dilution' May Hold Back AT&T; Stock Near-Term, Some Say

AT&T; Corp. may have dialed the right number with Tele-Communications Inc. in terms of long-term strategy, but in the short run some Wall Streeters are worried about AT&T;'s stock.

The reason: The deal would mean lower earnings for AT&T; for three years, the company conceded. And the type of institutional investor that now dominates AT&T;'s shareholder ranks may have a hard time dealing with that earnings dilution.

Market reaction was ugly Wednesday. AT&T; tumbled $5.38 to $60, ending near the day's low.

Although it's not unusual for shares of an acquiring firm to fall immediately after a merger announcement, some analysts said the extent of the sell-off was surprising.

What's the problem? Here's how Wall Street analysts and money managers see the situation.

First, AT&T; management had been pumping up the stock in recent weeks by painting a good outlook for earnings in the second half. AT&T; naturally wanted the stock at the highest possible price when the deal was announced.


Although the acquisition of TCI makes sense strategically--giving AT&T; the local access it desperately needs to compete with regional telephone companies--the price isn't cheap. With the issuance of new AT&T; shares to pay for TCI, and a much higher debt load, AT&T;'s 1999 earnings per share are expected to be in the $3 range, down from Wall Street's previous estimate in the $4 range.

That profit decline might not be a problem if most current AT&T; shareholders viewed the company, and the stock, in the same light as TCI shareholders view that stock--as more of a cash-flow story than a bottom-line earnings play.

But analysts point out that many of the institutions that poured into AT&T; stock over the last year were value players attracted by the company's earnings turnaround prospects and its dividend yield, which was nearly 4% at the stock's low last year. (It's now 2.2%.)

With earnings dimmed near-term, "a lot of the 'yield hogs' will leave the stock now," one analyst said.

What's more, the structure of the deal--in particular, the planned issuance of a "tracking stock" for the merged company's consumer businesses (including cable, long-distance and wireless)--won't thrill many of the value players in AT&T; stock, some experts argue.

"That isn't the way they think" about stocks, one analyst said of AT&T;'s institutional investors, noting that the tracking stock would simply offer a way for the market to value the merged company's consumer businesses but would not constitute actual ownership of those businesses.

It would make more sense, one analyst said, to have a stock tracking the consumer businesses and another stock tracking AT&T;'s corporate businesses, rather than have a consumer-unit stock that simply trades alongside shares of the parent company.

"The structure is totally flawed," one institutional investor said.

Finally, many investors on Wednesday said the deal focused the market on just how much money (and/or stock) AT&T; may have to lay out in the next few years to build a company that can compete at the local level and in the long-distance market.

"Everything AT&T; needs to do strategically is dilutive to earnings," one investor said. That also may be true for the Baby Bells and other AT&T; competitors, but not to the same extent, the investor said.

So where is AT&T; stock likely to settle, short-term? AT&T; argued that the consumer unit should be valued at $28 to $36 a share and the rest of the company at $40 to $48 a share, based on its cash-flow expectations. Total value for AT&T; stock: $68 to $84, AT&T; says.

Some analysts say $50 to $60 may be more likely. If $3 a share is a reasonable earnings estimate for 1999, at $60 the stock's price-to-earnings ratio is about 20.

That's higher than the P/Es the market now affords such AT&T; rivals as Bell Atlantic. But if AT&T; can convince the market that the addition of TCI's cable business is sure to boost long-term earnings prospects, a 20 P/E in a still-highflying bull market may not sound outrageously expensive.


AT&T;'s Buildup

AT&T; shares have risen recently as management sought to pump up the stock price ahead of the deal, some analysts say. Weekly closes and latest:


Wednesday: $60


Source: Bloomberg News

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