AT&T Has to Change, Says Elliott Management

Perhaps it never is a good sign when a major institutional investor calls for changes. That virtually always is an indicator that a firm is not performing as well--as an asset--as the market expects. AT&T now is getting such attention from Elliott Management.

It is never difficult to find investor, equity analyst or commentator criticism of AT&T's major acquisitions since the failed effort to acquire T-Mobile US. Others might point to the deals since the DirecTV acquisition. Though execution sometimes is the main complaint, strategic error is the most common charge. By way of comparison, such critics say, Verizon has done better by sticking to its connectivity knitting. 

It is not an easy matter to decipher, at this point. AT&T equity performance has lagged the market, Verizon and T-Mobile US. Concerns about debt taken on to fuel the acquisitions is a frequent concern. 

Granting the concerns, there is another way to view the acquisitions (execution notwithstanding), and that is as a rational strategy. When an industry reaches a key turning point in its lifecycle, “doing more of the same” might well be called a questionable strategy, especially for the leaders in that industry. 

Without much question, core products ranging from voice to messaging to internet access and linear video are past their peak, and getting close to a peak. The huge attention being paid to 5G, edge computing and internet of things can be interpreted as evidence of that maturation. 

With the caveat that some might fault the execution, not the strategy, or the choice or assets, rather than the strategy, AT&T has diversified its position in the internet ecosystem substantially since 2010. Verizon has not done so. One might well make the argument that none of these businesses is a fast grower. But one might also argue that some of these lines of business stand a better chance of holding their own, while providing exposure to multiple roles within the ecosystem, not simply the “connectivity” role. 

Facing natural limits in its core market, any firm might rationally consider a change of business model and product set. Where would Facebook or Google be today had they not pivoted to a “mobile-first” strategy? What if Paypal PayPal had stuck to its original cryptography plan? What if Apple had stuck to PCs? What if YouTube had remained a site for quirky videos?

What if Singtel had remained a “Singapore only” telecom firm? The point is that the connectivity business, traditionally a no-growth or slow-growth business with guaranteed profits now is a no-growth or slow-growth business in a competitive environment. 

In fact, the U.S. Justice Department quashing the AT&T effort to buy T-Mobile US--on market concentration grounds--might validate the ”limited growth in the core business” argument. Justice Department officials made it clear that AT&T would not be allowed to get bigger in the U.S. mobile market. 

Even in failure to get antitrust approval, AT&T was confronted by the absolute need to look for growth elsewhere than in its traditional core businesses. The damage, one might argue, were the terms of the deal breakup fee, which allowed T-Mobile to fund its market attack. 

One can argue with the precise assets acquired, the strategy behind those acquisitions or the execution and integration, without disagreeing that AT&T has to find massive new revenue sources to fuel its growth and pay its dividends. 

By implication, many other tier-one service providers will have to undertake similar diversification moves. The issue is not “conglomerate or not.” It is hard to escape the conclusion that tomorrow’s tier-one connectivity providers will have transformed, much as Comcast has changed from a video distributor into a firm active in many parts of the internet ecosystem (theme parks, movie production, network ownership, business services, wireless and mobile). 

One might argue alternative major assets should have been purchased, though it is hard to see how the free cash flow from DirecTV could have been gotten from any other feasible acquisition. And if content ownership as a building block of tomorrow’s video subscription business is necessary, few assets other than Time Warner were available, providing both segment scale and free cash flow, within the constraints of the debt burden to be imposed. 

The point is that the U.S. connectivity business is growing very slowly, while every major product category is either in the declining phase of its life cycle, or will be, soon. 

Other firms have other options, as often is the case in any market with a few dominant providers and many upstarts and specialists. “Grow by taking share” still makes sense for T-Mobile US and many other smaller connectivity providers. It is not an option for AT&T, for the most part. 

As the largest U.S. connectivity services provider, AT&T has to expect to lose share, even if it executes well. 

None of that will spare AT&T criticism over its equity valuation, strategic choices, acquisitions  or execution. But the move to occupy different roles within the ecosystem (“moving up the stack,” some might say) is hardly foolhardy. It is a rational response to market circumstances and product life cycles.