By Steve Rosenbush
Is AT&T (T ) finally digging itself out of its deep, deep hole? There was cause for hope on Apr. 23, when the long-distance giant announced first-quarter operating profits of $529 million -- a juicy 22% higher than expected. Though much of the gain came from companywide cost cuts, investors were more impressed with a big improvement in AT&T's huge Business Services unit. With revenue declines slowing from a flood to a trickle, the company's stock price soared 23%, to $17 on the news. Adding to the optimism, talks over a key strategic merger with BellSouth Corp. (BLS ) could resume this month. And new CEO Dave Dorman said AT&T would meet or beat this year's financial forecast. All good news, right?
Not good enough for some. AT&T shares gave up much of their gain over the next few days, as analysts downgraded the stock, arguing that the improvements won't last. The concern: Nearly $55 million of AT&T's profits stemmed from favorable changes in the tax code and accounting changes. "There is a major question as to how sustainable these results are," says Alex Peters, manager of the $200 million Franklin Templeton funds, who sold his AT&T shares earlier this year.
Clearly, AT&T naysayers have plenty to worry about. Six months after selling off its cable-TV unit to Comcast Corp. (CMCSK ), the company is struggling to remake itself. It won't get any help from its local and long-distance consumer unit, which accounted for about 30% of its $37.8 billion revenues in 2002. In the first quarter, consumer revenues declined 18%, to $2.53 billion. The falloff promises to worsen as the Baby Bells get more aggressive in long distance. Indeed, due largely to the reeling long-distance market, most analysts expect the recent surge in profits to taper off.
So why do the optimists figure the worst is almost over? They're banking on the efforts of 49-year-old Dorman, who took over from C. Michael Armstrong late last year, to get AT&T back on track. Dorman's focus: spurring growth in business services, which generated about 70% of the company's $37.8 billion revenue in 2002. He's working to ensure that when the long-awaited economic uptick occurs, particularly in telecom-intensive financial services, AT&T will be better poised to benefit than many of its competitors.
Already the tide seems to be turning. With MCI Group (MCWEQ ) still in bankruptcy, it has lost about 3% of its share in the small and medium-size business market. Much of that went to AT&T. Indeed, a host of troubled telecom carriers have lost share to AT&T in such areas as Internet and other data services, according to AT&T president Betsy Bernard. "We are taking advantage of the disadvantaged situation of our rivals," she says.
A recent survey of telecom customers by investment firm Friedman, Billings, Ramsey & Co. shows many favor AT&T, even when rivals offer discounts of 20% or more. One example: Harvey Borden, director of information technology at G&G Retail Inc., a privately held retail company in New York with 600 stores. He recently switched to AT&T because he was worried about MCI's stability.
Such gains have nearly stopped the slide in AT&T's business-services revenues. After falling 8% in the first quarter of 2002, business revenues fell only 1.5% in the same quarter of 2004. And if the economy brightens, revenues should grow in the low single digits over the next year. That may not sound like a big deal, but after the massive cost cuts of the past few years, any revenue gains would have a big impact on the bottom line. Susan Kalla, an analyst with Friedman, Billings, Ramsey, thinks that kind of growth could boost 2004 operating income 50% above consensus estimates of $1.1 billion.
An even bigger boost could come if AT&T succeeds in merging with BellSouth, with its extensive local operations. Merger talks were held last year, but were halted as AT&T was immersed in the sale of its cable-TV unit. New negotiations could resume as early as May 18. A deal would enhance AT&T's ability to integrate local, long-distance, and wireless services over its own networks.
No one is expecting miracles from a much-shrunken AT&T. But if it can revive growth in its business-services sector, which would ensure modest profits, the 126-year-old company may yet breathe new life.
Rosenbush covers the telecommunications industry from New York.