AT&T’s transition to 5G means huge upfront costs. And it needs HBO Max to succeed.

AT&T Inc. was staring down a series of daunting business transitions when the pandemic dealt it a blow that has left the company bruised as it faces the second year of COVID-19.

Even before the crisis began, AT&T

faced the challenging and costly tasks of securing its wireless future in 5G and adapting its WarnerMedia business to the world of streaming, all while maintaining a heavy debt load due to acquisitions. While the wireless business mostly held up due to the pandemic, AT&T’s media business took a profit hit, adding incremental financial pressure at a time when the company was set to embark on expensive strategic shifts.

Looking back at 2020, AT&T put things bluntly in its last earnings release: “The COVID-19 pandemic impacted revenues across all businesses.” With international travel largely on pause, fewer wireless consumers were racking up roaming charges. AT&T’s media business was hurt by theater closures and an advertising slowdown.

AT&T may not have been so exposed to economic volatility had the company not “snatched defeat from the jaws of victory in that it bought media businesses near the top of the cycle,” Bernstein analyst Peter Supino said.

Untangling the pandemic’s impact on AT&T’s financial situation can be somewhat complicated given everything else afoot at the company, but a pretty obvious pattern emerges when compared with other telecoms giants. The company’s adjusted earnings per share felt 11% in 2020, while Verizon Communications Inc.
which has remained largely focused on telecommunications services, saw adjusted earnings per share rise 2%.

See also: Will 5G ever live up to the hype?

Pure telecommunications businesses are less sensitive to downturns because people view wireless services as fairly essential, but AT&T’s diversification into media through its WarnerMedia and DirecTV deals meant that it felt a sting from the pandemic and its resulting impact on the economy, Supino explained.

AT&T ended up taking a $780 million charge as it wrote down the value of some production and content inventory at WarnerMedia owing to theater shutdowns and the company’s plans to make many 2021 films available for free to subscribers of its HBO Max streaming service on the same day that they hit theaters.

AT&T also shed nearly 3 million premium TV subscribers in 2020 across its various brands — but that business had been eroding long before the COVID-19 crisis began, and subscriber losses actually lessened during 2020 as subscribers sheltered in place. The company ultimately opted this February to spin DirecTV and its other videos businesses into a separate company, with TPG Capital taking a 30% stake.

Supino said that his overall forecast for AT&T’s 2020 earnings before interest, taxes, depreciation, and amortization (Ebitda) fell by about 5% from pre-pandemic levels. The impact of that pressure on AT&T’s leverage ratio “really isn’t that bad,” he argued. “Ultimately AT&T’s leverage position was high because of the acquisitions that it made and its inability to grow.”

MoffettNathanson analyst Craig Moffett took a harsher stance. “Debt is another word for risk,” he said. “When the recession came, their balance sheet simply wasn’t ready for it,” leaving AT&T with a drop in earnings that “became a real impact to their financial flexibility.”

The COVID-19 crisis “obviously didn’t help” AT&T with its debt-reduction goals, said Edward Jones analyst David Heger, but the “big elephant in the room is the C-band auction.” A recent auction for critical 5G spectrum proved more than twice as expensive as analysts originally expected, and AT&T had to take on some new debt to help finance its more than $23 billion in spectrum commitments.

AT&T’s financial situation is made more complicated by the fact that the company is under pressure to maintain its dividend, with the stock currently yielding 6.9%. The company has maintained that the dividend is secure.

Shares of AT&T have gained 0.6% over the past 12 months, while shares of Verizon have risen 2.5% and shares of T-Mobile US Inc. have gained 50.8%.

The path forward

Now the company is gearing up for the economic rebound. Its cable networks, like TNT and TBS, lost out on advertising revenue last year when March Madness was canceled, but the tournament returned this year. Cinemas are slowly reopening with capacity restrictions, and while Warner Bros. is using its film slate to help drive HBO Max streaming subscriptions, the company could also gain from an eventual return to theaters from those looking to get out of the house.

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More benefits could come from some behavioral changes that took place during the pandemic.

AT&T expects to be able to lower its cost of wireless store operations now that consumers have become more willing to buy phones online. The company has also set out to expand its fiber footprint, capitalizing on a growing need for fast at-home data speeds to handle increased video conferencing and other functions. AT&T targets 3 million new fiber locations during 2021 and could add even more than that in 2022.

Traditional connections were more focused on download speeds, said Supino, but two-way video requires an emphasis on upload speeds as well.

“Upstream is actually accelerating faster than downstream consumption,” AT&T Chief Technology Officer Andre Fuetsch recently told MarketWatch. “That’s significant because that makes symmetrical networks [like fiber] much more relevant.”

Still, there’s debate among analysts about AT&T’s financial ability to navigate the bigger transitions under way.

The pandemic accelerated the adoption of streaming services like HBO Max, which launched in the thick of the crisis, but AT&T also has legacy media businesses that will be hurt by the shift in how people consume media. The question is whether AT&T will be able to spend what’s necessary—and absorb early losses—to effectively navigate the move to streaming.

“WarnerMedia is in the midst of a brutal transition from what TV and movies used to be to what TV and movies are headed toward,” Supino told MarketWatch. Consumer churn can be higher in streaming than with legacy media services, and more traditional players like WarnerMedia now have to compete with nontraditional players like Inc.

and Alphabet Inc.’s


“The logical extension is that it’s going to cost more to have a given amount of market share you and you have to work harder to keep it,” he said, noting that he’s “very worried about [AT&T’s] ability to spend as much as they should on WarnerMedia.”

Moffett argued that Walt Disney Co.
a traditional media company that’s made substantial inroads in streaming thus far, has “set the bar high” by “announcing aggressive losses to send Disney+ into the stratosphere.”

HBO Max, which launched last May, has 41.5 million U.S. subscribers and a goal of reaching 120 million to 150 million global subscribers by the end of 2025. Though the service launched in the middle of the pandemic when demand for streaming was high, Heger said the service may have gotten off to a slow start, in part because it didn’t initially have distribution arrangements with popular platforms like Roku Inc.

Disney+, which launched in November 2019, has 94.9 million global subscribers and a target for 230 million to 260 million by the end of 2024.

As with television, the movie business has also been upended by COVID-19, and the path forward is somewhat unclear.

“The idea that theatrical releases might do very, very well early in the reopening is not crazy,” Moffett said. “The real question is whether that short-term rebound has any legs to it.”

Warner Bros.’ plan to make most of the top movies from its 2021 slate available on HBO Max on the same day they hit theaters was dubbed a one-year-only deal to cope with uncertainty about theater attendance, but even so, it’s unlikely that film studios will ever go back to the way things used to be, with 90-day windows of theatrical exclusivity.

While Warner’s embrace of streaming for film releases was the most dramatic, Disney and Comcast Corp.’s

Universal both shortened the window, and many analysts expect narrower windows could become the norm, shifting the economic model of feature films more toward streaming.

The other big transition is occurring in wireless, as AT&T and its rivals work to build out their 5G networks. The wireless companies face pressure to deliver faster speeds nationwide, or they risk losing subscribers to competitors, and that’s meant they’ve had to spent heavily to acquire mid-band wireless spectrum, which will help enable enhanced 5G connectivity.

Though AT&T has already started rolling out what it calls nationwide 5G coverage, that network is built on a type of spectrum that offers hardly any benefits in terms of speed and lag time. The process of rolling out faster coverage that relies on mid-band spectrum will take years and T-Mobile US

has an advantage because was already sitting on a large amount of mid-band spectrum before the recent auction. The spectrum AT&T and Verizon got at the auction only becomes available for use in stages, with the first batch not being accessible until the end of this year.

Read: Why Verizon, AT&T and T-Mobile just spent $80 billion in an auction, and what it will mean for 5G

Supino likens the process of building out a 5G cycle to expanding a freeway, which requires adding new lanes next to an existing highway and absorbing the cost of that process before the new lanes are available for use. Right now AT&T’s process is in a “period of peak inefficiency,” he said, “and AT&T is facing that with capital constraints.”

Moffett echoed those concerns. “You have to believe the enormous amount of money that will be required to build a competitive network in 5G will be constrained by their lack of financial flexibility.”

Heger took a more upbeat view. “They certainly have a plan to be able to get the debt paid back and invest in the business as they need to,” he said. “They’re going to have to prove all that to investors because investors have not been giving them a lot of credit for their strategy. From a valuation point of view, it makes sense that the stock could be worth more if they execute on what they’re trying to do.”

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