At&T: A Guide For The Perplexed

First impressions aside, it makes sense to hold on to undervalued AT&T shares rather than swap them for Wireless

Is there a widow or orphan who still holds stock in AT&T (T)? Heaven help them. Along with 4.8 million fellow investors, they soon must decide whether to keep shares that trade no higher today than four years ago or swap them for a stake in the wireless future. Put that way, making the right choice seems simple. Except it's not.

Last spring, AT&T sold a 16% interest in AT&T Wireless (AWE), its cellular-phone and mobile-messaging unit, to the public. Now, it's preparing to trade up to $10 billion worth of its Wireless shares, in exchange for outstanding AT&T common stock. If you own AT&T stock, you may swap none, some, or all of your shares, tax-free. The question is, should you?

For patient investors, I say the answer is no. Yes, with its long-distance operation shrinking, there's an aura of desperation about AT&T. Yes, by contrast, Wireless last year enjoyed healthy surges in subscribers (59%) and revenue (37%). And yes, the uncertainty around AT&T's plan to split into four separate companies in the next 18 months is enough to make anyone want to trade AT&T stock for Wireless. But look at what you would be throwing away (table). You would swap what's cheap for what's fully priced. "Wireless is a very good business," says Bill Nygren, an AT&T bull who runs $4 billion for Oakmark Funds. "I just don't see an unusual opportunity."

The opposite is true of AT&T, which the stock market lately has valued at $90 billion. At the same time, it values Wireless at $58 billion. Since AT&T still owns 84% of Wireless, its stake is worth $49 billion. Take Wireless out of AT&T and the difference, $41 billion, is the implied value of everything non-Wireless. Just eyeballing it, that looks low: $41 billion barely buys Telefonos de Mexico (TMX). It looks even wackier when you know that Wireless makes up 54% of AT&T's market value, yet contributed just 12% of its $9.4 billion in earnings before interest and taxes last year.

Try also looking at AT&T piece by piece. Chief Executive C. Michael Armstrong's plan is to turn shares in today's AT&T into four stocks, each tied to a distinct operation: Business, Consumer, Broadband, and Wireless. If they all traded separately now, what might they be worth?

-- Business. AT&T'S biggest part, offering a variety of corporate services, collected $28.5 billion in revenue last year. Archrival WorldCom's (WCOM) shares trade for 1.6 times sales. Apply that multiple to AT&T Business, and you get a value of $46 billion, or $12 per AT&T share.

-- Consumer. Persistent price-cutting on residential long-distance accounts trimmed revenue 9.5% last year, to $19 billion. Shares of similarly troubled Sprint FON Group (FON) go for 1.2 times sales. At that, AT&T Consumer would be worth almost $23 billion, or about $6 per AT&T share.

-- Broadband. Revenues from AT&T's cable-TV and high-speed-data services last year grew 10%, to $8.2 billion. Using Comcast's (CMCSA) middling price-sales multiple of 5, Broadband would be worth $41 billion, or almost $11 an AT&T share.

-- Wireless. Because investors are already trading Wireless shares, its price-sales multiple is known: 5.5 times last year's sales, a bit more than the multiples given to rivals Nextel Communications (NXTL) and Sprint PCS Group (PCS). Each AT&T share holds nearly $13 in Wireless value.

Add it up, and you get a back-of-the-envelope value for AT&T of $42 a share. At that, it seems plain that AT&T is worth a lot more than its recent price of $24 a share. The patient investor should be able to pocket the difference. As for Wireless, it's trading at $25, a buck above what NTT DoCoMo, Japan's cellular leader, paid in January for a 16% interest. Does DoCoMo's bet suggest Wireless has a bright future? Yes. But keep your AT&T, and you'll eventually get some Wireless, too.

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