8/25/2011

AT & T INC.

EQUITY RESEARCH REPORT

Submitted by: Ankit Gupta Rudra Shankar Chowdhry Srikanth Kumar Konduri 10FN-014 10FN-097 10FN-109

Based on DCF Valuation | STP Submitted to

AT & T Inc. 2 Equity Research Report

Contents
AT&T........................................................................................................................................................ 3 Company Profile:................................................................................................................................. 3 Financial Outlook: Latest published quarterly reports (2Q-2011) ...................................................... 3 Key Businesses: ................................................................................................................................... 4 WIRELESS: ....................................................................................................................................... 4 WIRELINE:........................................................................................................................................ 4 ADVERTISING SOLUTIONS: .............................................................................................................. 5 OTHER: ............................................................................................................................................ 5 Financial Performance: ....................................................................................................................... 6 Key trends in Business & Operations: ................................................................................................. 6 Revenue Trends: ............................................................................................................................. 6 Expense Trends: .............................................................................................................................. 7 AT&Ts proposed acquisition of T-Mobile: ......................................................................................... 7 AT&T acquisition of spectrum controlled by Qualcomm: .................................................................. 7 Impacts of past acquisitions: (STT, AT&T merger in 2006) ................................................................. 8 Competitive Landscape: ...................................................................................................................... 9 Standalone valuation: ....................................................................................................................... 10 Risk factors: ....................................................................................................................................... 11

AT & T Inc. 3 Equity Research Report

AT&T
Company Profile:
AT&T Inc., together with its subsidiaries, provides telecommunication services to consumers, businesses, and other service providers worldwide. AT&T, along with its subsidiaries and affiliates, provides a variety of telecom services including local wireless communications service, long-distance phone service, wireless and data communication, roaming services. It also provides Internet access and messaging, IP based and satellite television. The company is also into security services, telecommunication equipment selling, directory advertising and publishing. In April 2010, AT&T Inc. sold its remaining stake of more than 7% in Tech Mahindra Limited. In June 2010, the Company completed the acquisition of wireless assets from Verizon Wireless. In July 2010, the Company divested its Wayport Holdings A/S to Hospitality Services Plus SA. In August 2010, the Company completed divestiture of Sterling Commerce to IBM. Largest number of total broadband connections in US with fastest network: Wired residential broadband Largest Wi-Fi network in US based on branded and operated hotspots Wireless (including mobile broadband) 3-Screen integration strategy to deliver services across: The mobile device The PC The TV

Financial Outlook: Latest published quarterly reports (2Q-2011)

Sales rose 2.2% to $31.5 billion, net income declined 10%, and earnings per share were 60 cents. Reported a 39% surge in margins during the quarter driven by a strong wireless revenue growth and sales of smartphones Major Concern is loss of exclusive rights to sell Apple Inc.'s iPhone. AT&T cut the price of the older 3GS model to $49 to entice customers to stay. Significant increase in net additions, strong sales of branded computing subscribers and higher post-paid ARPU Continuous investment to upgrade its network services Introduced its new cloud-based Content Delivery Network (CDN) platform. Constant efforts to enhance its broadband deployment and high speed internet connections in rural area

AT & T Inc. 4 Equity Research Report The gain of 331,000 contract users at AT&T, which is seeking to buy T-Mobile USA Inc., beat the average estimate of 96,000.

Key Businesses:
It operates in four segments: wireless, which provides both wireless voice and data communications services across the United States and, through roaming agreements, in foreign countries; wireline, which provides landline voice and data communication services, AT&T U-Verse TV, high-speed broadband and voice services (U-Verse) and managed networking to business customers; advertising solutions, which publishes Yellow and White Pages directories and sells directory advertising and Internet-based advertising and local search, and other, which provides results from customer information services and all corporate and other operations.

WIRELESS: Wireless consists of the Companys subsidiary, AT&T Mobility, which operates as a wireless provider to both business and consumer customers. The Wireless segment provided approximately 47% of the segment operating revenues during the year ended December 31, 2010. At December 31, 2010, the Company had more than 95 million wireless subscribers. It classifies its customers as either postpaid, prepaid, connected device or reseller. It offers a range of wireless voice and data communications services, including postpaid and prepaid service plans. Its voice service is offered on a contract basis for one- or two-year periods, referred to as postpaid. Service is billed and provided on a monthly basis according to the applicable rate plan chosen. The wireless services include basic local wireless communications service, longdistance service and roaming services. Roaming services enable subscribers to utilize other carriers networks when they are roaming outside network footprint.

The Company sells a variety of handsets, wirelessly enabled computers (such as notebooks and tablets) and personal computer wireless data cards manufactured by various suppliers for use with its voice and data services. It sells through its company owned or through agents or third-party retail stores. It also sells accessories, such as carrying cases, hands-free devices, batteries, battery chargers and other items, to consumers, as well as to agents and other third-party distributors for resale.

WIRELINE: The Wireline subsidiaries provide both retail and wholesale communication services domestically and internationally. The Wireline segment provided approximately 49% of the segment operating revenues during 2010.

AT & T Inc. 5 Equity Research Report The Company divides its wireline services into three product-based categories: voice, data and other. Voice includes traditional local and long-distance service provided to retail customers and wholesale. At December 31, 2010, the wireline subsidiaries served approximately 23 million retail consumer access lines, 19 million retail business access lines and two million wholesale access lines. It has a of integrated voice and data services, such as integrated network connections, that provide customers the ability to integrate access for their voice and data services, the data component of which is included in the data category. Long distance also includes services provided by calling card, 1-800 services and conference calling. These services are used in a variety of business applications, including sales, reservation centers or customer service centers. The Company provides data services that rely on Internet Protocol (IP)-based technology and data services that rely on circuit-based technology. The managed Web-hosting services for businesses provide network, server and security infrastructure, as well as built-in data storage and include application performance management, database management, hardware and operating system management. The hosting services also provide customers with secure access to detailed reporting information about their infrastructure and applications. Packet services consist of data networks using packet switching and transmission technologies, including traditional circuit-based, and IP connectivity services. High-speed packet services are used by enterprise (large business) customers. Enterprise networking services provide support from network design, implementation and installation to ongoing network operations and management for networks of varying scales. Security services include business continuity and disaster recovery services, as well as premise and network based security products.

ADVERTISING SOLUTIONS: Advertising Solutions includes directory operations, which publish Yellow and White Pages directories and sell directory advertising and Internet-based advertising and local search. The Advertising Solutions segment provided approximately 3% of total segment operating revenues during 2010. This segment sells advertising services throughout the United States, with print directory operations primarily covering its 22-state area.

OTHER: The Other segment includes customer information services (such as operator services) and corporate and other operations.

AT & T Inc. 6 Equity Research Report The Other segment provided approximately 1% of total segment operating revenues during 2010. The Company also includes in this segment the equity income (loss) from its investments in Telmex and America Movil. In August 2010, it sold Sterling Commerce Inc. (Sterling).

Financial Performance:

Key trends in Business & Operations:

Revenue Trends: The operating environment in 2011 will remain challenging as weak economic conditions continue and competition remains strong. Despite these challenges, it is expected that At&T will grow its operating revenues in 2011, reflecting continuing growth in wireless data and IP-related wireline data services including U-verse and business services. The primary driver of growth is expected to be wireless, especially in sales of and increases in data usage on advanced handsets and emerging devices (such as tablets, eReaders and mobile navigation devices). All major customer categories are expected to show increase in their use of Internet-based broadband/data services. Continuing declines in traditional access lines and in print directory advertising is anticipated. Where available, U-verse services have proved effective in stemming access line losses, and this is expected to continue in 2011.

AT & T Inc. 7 Equity Research Report Expense Trends: To focus sharply on cost-control measures, including areas such as simplifying product offerings. Continue on-going initiatives to improve customer service and billing to realize the strategy of bundling services and providing a simple customer experience. 2011 operating income margin is expected to improve, as revenues improve. Expenses related to growth areas of our business, especially in the wireless, U-verse and strategic business services areas, will apply some pressure to operating income margin. In addition, as the company complete readying their Long-Term Evolution (LTE) technology for its intended use, it will no longer capitalize interest on this spectrum.

AT&Ts proposed acquisition of T-Mobile:

More wireless spectrum for expanding its upcoming 4G LTE network. Expect the transaction to close in ~12 months, depends on the review by Federal Communications Commission (FCC) and Department of Justice (DOJ)

AT&T assumes no debt from T-Mobile or Deutsche Telekom. (actual $15.9B till 2010 end) Unsecured bridge loan facility from JP Morgan ($20B in 18 months) Strong balance sheet of AT&T; >$12B FCF after dividend for past 2 years Terms: (AT&T rated B3H, 3rd lowest investment grade rating, sustains for further $25B debt) Purchase Price: $39B ; ~7.1x T-Mobiles 2010 EBITDA Cash ~ 64% AT&T shares ~36% (8% stake in AT&T; Issue of $14B shares to Deutsche Telekom)

Combined Financials (2010 End figures) AT&T T-Mobile Total 96M 34M 130M Wireless subscribers* $53.5B $18.7B $72.2B Wireless service revenues $58.5B $21.3B $79.8B Total wireless revenues 41% 29% Wireless service EBITDA margin $62.57 $52.00 Postpaid ARPU 0.0131 0.034 Total churn * combination to hold 43.46% of US Mobile Subscription (31.03.2011)

AT&T acquisition of spectrum controlled by Qualcomm:

Company expects the 12MHz of the lower 700MHz D & E block spectrum to play a key role in its 4G plans. FCC is taking a coordinated look at this proposition along with above. The deal is expected to be closed by 2nd half of 2011. Purchase price: $1.925B.

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Impacts of past acquisitions: (STT, AT&T merger in 2006)

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Competitive Landscape:
A competitor comparison of USA Wireless market shares:

Source: Indigo Equity Research, Company Data It can be inferred from the above graph that the competitiveness in this sector is becoming ineffective as more than 80% of the market share being concentrated with top 4 players. AT & T is the 2nd largest player in the telecommunications industry of USA with 32% market share, it is only a step away from surpassing Verizon and becoming the leading market player once its proposed $39bn acquisition of T-Mobile gets regulatory nod. Acquisition will provide AT & T the required spectrum needed to aggressively roll-out LTE based 4G services. Beginning with Atlanta, Chicago, Dallas, Houston and San Antonio, it plans to spread its services across 15 markets to reach 70 million Americans by late 2011. By 2013, AT&T intends to extend its 4G network to 97% of US population. Removal of customer checks and offering unlimited pre-paid plans with credit facilities, targeting youth customers has positioned Leap Wireless as a niche player and indirectly compete with AT&T. A basket of sub-brands Sprint, Nextel, Boost Mobile, Virgin Mobile and Assurance Wireless sub-brands makes Sprint Nextel a strong competitor in both wireless and wireline segments. However, it has been significantly losing out customers recently. A focused approach on targeting densely populated urban youth & minority pre-paid segments is proving worthy for MetroPCS, though the company lacks the scale of AT&T or Verizon, it need not rely on massive capital expenditure & helped it to comparatively higher margins. Rivals in the 4G space: o Though AT & T is the only company that delivers 4G services using both LTE & HSPA technologies, it is well behind to Verizon Wireless in LTE network deployment. The joint venture between Verizon Communications Inc. (VZ) and Vodafone Group plc (VOD) has already rolled out the LTE network in 102 markets, reaching around 160 million customers.

AT & T Inc. 10 Equity Research Report o 4G services of 3rd largest wireless company Sprint Nextel Corp. (S) have already spanned across 71 U.S. markets and reached 120 million people by 2010. It is likely to cover 130 million customers by the end of 2011.

Standalone valuation:
We value AT&T using discounted cash flow (DCF) considering Weighted Cost of Capital as 7.02% and terminal growth rate as 1.5%. The fair value appears to be $42.45, a potential upside of 46% based on its last traded price of $29.06. The following are the underlying assumption used in DCF: Parameter Risk free rate Beta Equity risk premium Cost of debt Debt/Equity Tax rate Value 4.50% 0.66 5% 6.70% 40.60% 24%

DCF Sensitivity Analysis by varying WACC against Terminal Growth Rate: Equity Value 42.36 6.92% 6.97% 7.02% 7.07% 7.12% Terminal Growth Rate 1.00% 40.18 39.93 39.69 39.44 39.21 1.25% 41.49 41.22 40.96 40.69 40.43 1.50% 42.93 42.63 42.34 42.05 41.77 1.75% 44.50 44.18 43.86 43.54 43.23 2.00% 46.24 45.88 45.52 45.18 44.84

WACC

AT & T Inc. 11 Equity Research Report DCF Sensitivity Analysis by varying COGS margin against Total Revenue Growth Rate: Equity Value 42.36 -1.00% -0.50% 0.00% 0.50% 1.00% COGS/(Total Revenue) Growth Rate -1.00% 42.82 52.70 64.53 78.64 95.40 -0.50% 35.33 43.58 53.44 65.20 79.15 0.00% 27.85 34.46 42.36 51.76 62.91 0.50% 20.36 25.33 31.27 38.31 46.66 1.00% 12.87 16.21 20.18 24.87 30.42

Total Revenue Growth Rate

Risk factors:
A worsening U.S. economy would magnify our customers and suppliers current financial difficulties and could materially adversely affect our business Adverse changes in medical costs and the U.S. securities markets and interest rates could materially increase our benefit plan costs. The ongoing uncertainty in global financial markets could materially adversely affect our ability and our larger customers ability to access capital needed to fund business operations. Changes in available technology could increase competition and our capital costs. Changes to federal, state and foreign government regulations and decisions in regulatory proceedings could materially adversely affect us. Increasing competition in the wireless industry could adversely affect our operating results. Increasing competition in our wireline markets could adversely affect wireline operating margins. Continuing growth in our wireless services will depend on continuing access to adequate spectrum, deployment of new technology and offering attractive services to customers. Equipment failures, natural disasters and terrorist attacks may materially adversely affect our operations. The continued success of our U-verse services initiative will depend on the timing, extent and cost of deployment; the development of attractive and profitable service offerings; the extent to which regulatory, franchise fees and build-out requirements apply to this initiative; and the availability and reliability of the various technologies required to provide such offerings. Unfavourable litigation or governmental investigation results could require us to pay significant amounts or lead to onerous operating procedures.