Some Investors Hanging Up on AT&T;

AT&T; (T)

Jim: Buy

Mike: Don’t buy

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Mike: We’re looking only at AT&T; today, Jim. We’ve reviewed it before, but now it’s very much in the news again and in the hearts and minds of investors everywhere.

Jim: And what a perfect stock for Halloween, Mike, because this one is a nightmare.

Mike: First, I want to take credit for one of the world’s greatest “to be sures,” which as you know is a term of art in our business. When you write a story that takes a stand but want to hedge your bet by tipping your hat to the other side, you throw in a line that starts “To be sure.” Say you’re writing: “The Israelis and the Palestinians are on the verge of peace.” You then add, “To be sure, they may very soon be at war again.” Then you can always claim you got it right.

Jim: It’s basically a big caveat.

Mike: When we last talked about AT&T; in August 1999, we were both optimistic about AT&T;’s plan to build an integrated telecommunications and cable-TV empire. But I ended our chat by saying, “this is great but . . . it better work.” And guess what? It hasn’t worked.

Jim: We both raised concerns about whether AT&T; and its chairman, C. Michael Armstrong, could pull this off. But truth be told, we don’t have much to take credit for. We both recommended the stock, and we were dead wrong.

Mike: Yes, we were optimistic when the stock was $51, and here we are today with AT&T; trading in the low $20s. However, we weren’t the only ones snookered by AT&T;’s visions of grandeur, cold comfort though that may be.

Jim: Maybe we should have listened more to our own caveats. We both said there were lots of risks in Armstrong’s plan, which was to move AT&T; away from its traditional but slowing long-distance telephone service and toward faster-growing cable, Internet and broadband services.

Well, AT&T; simply hasn’t executed this strategy well. Its earnings have gone sluggish. Investors have lost faith, and the stock got hammered, losing more than half its value this year.

Mike: And now AT&T; has a new plan--to break itself up, as announced last week.

Jim: In fact, this is the third AT&T; breakup since old Ma Bell was busted up in 1984. I don’t know, Mike, but now that I’ve seen AT&T; break up three times in my career, maybe I’ve been doing this too long.

Mike: No comment. But let’s put our finger on what’s wrong at AT&T.; Think of this gigantic company in terms of a fellow on a hand car on railroad tracks, who’s doing his best to pump up and down as fast as he can, because coming up behind him is a diesel engine at full steam. The diesel, in this case, is the deterioration of the long-distance business. The question is, will the guy on the hand car make it to the siding before he’s turned into dog food?

Jim: Your chap being Mr. Armstrong.

Mike: Yes, he was desperately trying to get AT&T; to the siding by combining AT&T;’s long-distance, cable, wireless and business-services units into one giant, profitable freight train.

Jim: Right. Over the last three years Mr. Armstrong spent more than $100 billion acquiring cable-TV companies to make AT&T;, as you said, a one-stop shopping center for delivering everything from phone calls to cable programs.

Mike: The trick was to get all this clicking before, as I said, the diesel train hit him in the rear end. The long-distance business is going away. You can now call anywhere in the country on land lines for 5 cents a minute. Meanwhile, people are moving their long-distance business from land lines to wireless in part because wireless long-distance is often free.

And guess what? One of the pioneers of that was AT&T;, which offered its wireless customers free long-distance.

Jim: So now AT&T; has this plan: AT&T; itself will keep the consumer long-distance and business-services groups, but will create a “tracking” stock for long-distance. Also, it will take the AT&T; Wireless unit (AWE), which already is a tracking stock, and spin it off into a separate entity.

Finally, it will do the same with its cable/broadband group, that is, create a tracking stock and then spin it off entirely.

Mike: Nice summary. But this breakup isn’t as clean as you might think.

Jim: Meaning?

Mike: They won’t really be independent of each other. First, they will be bound together by the AT&T; brand name. Also, to the extent that these entities want to integrate services, they will be bound by contracts requiring them to buy these services from each other. So they’ll be about as independent of each other as the Duke and Duchess of Windsor.

Jim: So what do we think of the stock now?

Mike: Well, let’s start with this note: One Wall Street analyst did an almost unheard of thing the day AT&T; announced its plan . . .

Jim: Spoke in plain English?

Mike: Actually, yes. She downgraded AT&T; to a “sell.” When was the last time you heard that happening to a big company?

Jim: And it’s even more rare when it involves a stock in the Dow Jones industrial average.

Mike: Right. Her concern was that, when a company undertakes a restructuring this dramatic, it means chaos inside the company for the foreseeable future. And I agree.

Jim: I happen to think she’s wrong.

Mike: Did I just hear right? You like this stock?

Jim: Yes.

Mike: Well, this is what makes horse races. Look, the one thing AT&T; now needs is for its managers to apply themselves to the business at hand. Instead, they’re going to be devoted, through the end of 2002, to working on this breakup--figuring out who gets the debt, who gets the equity, who gets the office buildings, who gets this executive or that engineer.

It’s going to be a complete mess, and in the process they’re going to lose a lot of these people. So what’s to like?

Jim: AT&T;’s stock price, for openers. It’s now so beaten down I think it can’t go much lower. Heck, it trades for only 13 times earnings per share. Now, I don’t discount that there’s lots of chaos ahead and that this is indeed a speculative investment . . .

Mike: That’s an understatement.

Jim: But once the dust settles, I’m convinced that the four stocks that will be created will easily be worth more than AT&T; is worth today. Maybe only one or two will even be worth more than AT&T; today.

Mike: By the year 2003, maybe.

Jim: It’ll probably happen a lot sooner than that. Think about it: AT&T; itself owns 85% of the AT&T; Wireless tracking stock, and that ownership today is worth about $11 to $12 a share. That means the rest of AT&T;’s huge business--all of it--is valued at around 10 bucks a share! Break them up and the combined values will go much higher.

Mike: But there are so many unknowns, such as the regulatory issues that must be cleared first, and tax issues. Come on, this deal is the Lawyers Reemployment Act of 2000.

Jim: I know that, Mike. But go back to AT&T;’s two previous breakups, and look at how much value was created with stocks of the companies that were spun out of AT&T.; The same will happen here. And don’t forget, one or more of these new AT&T; companies could easily be bought by a competitor, sending its stock higher as well.

Mike: Great, and in the meantime it looks as if AT&T;’s cash dividend will get cut or wiped out altogether.

Jim: You’re right about that. But I think the prices of all the new stocks will easily make up for the vanishing dividend.

Mike: I go back to the question of whether these new AT&T; companies or stocks will actually be separate. Get this: Armstrong maintains that his original strategy of putting everything under one roof still stands. He’s just breaking up the roof into four pieces. If AT&T; Broadband wants to offer long-distance service over its cable-TV lines, it has to contract with AT&T; Long Distance to do it. It can’t go to WorldCom or Sprint to do it, even if those companies can offer a better deal.

There’s also the issue of using these tracking stocks, as opposed to giving investors true ownership claims on these businesses. The record on tracking stocks has been mixed at best.

Jim: Valid points. Yet wouldn’t you agree, Mike, that AT&T;’s stock has been pummeled so badly that it can’t go much lower?

Mike: I’m not sure. I think there are real questions about the management skills throughout AT&T.;

Jim: So you think buying AT&T; today would be buying a dead-money stock, for at least many months?

Mike: Absolutely. Every so often something happens in the process of evolution that, in the vernacular of the genetics trade, is known as creating a monster. What happens to monsters is that they die. And I think Mike Armstrong is on the verge of creating a monster.

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Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends.

Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). Either can also be reached at Business Section, 202 W. 1st St., Los Angeles, CA 90012.

You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).