Warren Buffett Sold His Position In AT&T. Should You?

Warren Buffett sold AT&T (T) out of Berkshire Hathaway’s portfolio of high-yield dividend stocks during the first quarter of 2016.

Warren Buffett acquired his stake in AT&T during the third quarter of 2015 as a result of AT&T’s acquisition of DirecTV.

Buffett had owned DirecTV prior to the acquisition (his first purchase was in 2011), so his shares converted into AT&T stock once the deal closed because the acquisition was a stock and cash transaction.

Despite AT&T’s high dividend yield near 5% and seemingly cheap price-to-earnings multiple (14.2), Warren Buffett apparently thought there were more attractive options to put his money to work.

Like Warren Buffett, we prefer Verizon (VZ), which is held in Berkshire Hathaway’s portfolio as well as our Conservative Retirees dividend portfolio.

Let’s take a closer look at the safety and growth potential of AT&T’s dividend as well as the company’s overall appeal as a potential investment opportunity for dividend investors.

Business Overview

Upon closing its $49 billion acquisition of DirecTV in 2015, AT&T expanded its reach to offer connectivity services (e.g. voice/data, pay-TV, broadband internet) to 355 million people and businesses in the U.S. and Mexico.

AT&T is the largest carrier in the world with approximately 128 million subscribers. No other telecom business has ever had as many subscribers across each service line as AT&T does now.

Segments

Business Solutions (49% of 2015 sales): AT&T provides mobile and IP networks and integrated solutions to 3.5 million businesses, including nearly all the Fortune 1000.

Entertainment Group (24%): AT&T provides video, internet, and voice communication services to U.S. customers. The company is the largest pay TV provider in the world. Most of DirecTV’s operations reside in this segment

Consumer Mobility (24%): AT&T provides consumers with nationwide wireless voice and data service, including internet, video, and home monitoring services.

International (3%): AT&T’s wireless operations in Mexico and DirecTV in Latin America. The company’s LTE network in Mexico will cover 75 million people by the end of 2016.

Business Analysis

Most of AT&T’s markets are characterized by very high barriers to entry and are dominated by just a handful of companies, resulting in fairly predictable earnings.

Imagine trying to launch a competing wireless network. Not a single rational consumer would sign up for your wireless voice and data service if you couldn’t offer them nationwide coverage, which requires billions of dollars to be invested in spectrum and network infrastructure alone.

Over the last five years, AT&T has invested more than $140 billion to build and maintain one of the largest wireless, fiber, and IP networks in the world, and the company’s capital spending runs around 15% of service revenues.

AT&T spent over $20 billion on capital expenditures each of the last three fiscal years and invested nearly $18 billion for acquisitions of spectrum licenses last year to keep its leading wireless network performing.

New entrants lack the financial firepower to effectively compete with AT&T’s low cost structure, asset efficiency, and hard-to-replicate networks.

To make matters even more challenging for new competitors, most of AT&T’s markets are very mature. The number of total subscribers is simply not growing much.

In other words, it would be almost impossible for new entrants to accumulate the critical mass of subscribers needed to cover the huge cost of building out a cable, wireless, or satellite network.

In addition to covering network costs, AT&T’s scale allows it to invest heavily in marketing and maintain strong purchasing power for equipment and TV content. Smaller players and new entrants are once again at a disadvantage.

Barring a major change in technology, it seems very difficult to uproot AT&T. It’s much easier to maintain a large subscriber base in a mature market than it is to build a new base from scratch.

AT&T’s acquisition of DirecTV in 2015 could strengthen its competitive advantages and marked a significant shift in strategy for the company. Prior to the deal, AT&T generated close to 75% of its income from wireless operations.

DirecTV made AT&T the largest pay-TV provider in the world and launched the company down a path focused on cost synergies and bundling services to drive earnings higher.

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Disclosure: At the time of this writing, the author had no position in T and was long VZ.

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