(FW) AT&T Earnings Warning

(FT) MF Ralegh's Take

AT&T CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> dropped almost 10% today after warning second quarter profits would be 10% below expectations. Makes sense, no? No wonder Robert Allen said yesterday he would vacate his post sooner than expected. The Fool News crew brings you all the details of today's warning.

Transmitted: 9/24/96

This Special Section focuses on today's earnings warning from AT&T. A FoolWire details the information put out by the company and a Fool Take examines the competitive pressures that AT&T is currently facing.

We bring together the best of the Motley Fool and AOL's Personal Finance area to deliver this collection to you.

Glossary

FW = FoolWire (a Fool News product)
FT = FoolTake (a Fool's opinion)
BK = Background article

Enjoy,

Randy Befumo (MF Templar), a Fool

ALEXANDRIA, Va., September 24, 1996/FOOLWIRE/ --- Ma Bell forecast a weak second half this morning, sending shares of AT&T <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %> hurtling lower in heavy trading.

WHAT HAPPENED?

AT&T revised expectations for its fiscal third and fourth quarter this morning citing its investment for new services and competitive pressure in its core long distance business. The company stated that third quarter earnings will probably come in 10% below current consensus expectations of $0.92 EPS. Additionally the company said that the fourth quarter will also come in about 10% below current consensus estimates of $0.89 EPS, suggesting that the entire second half is going to be weak for the giant telecommunications concern.

WHAT DOES IT MEAN?

The company explained the profit shortfall as the result of a series of expensive marketing moves intended to accelerate volume and revenues in AT&T's long distance business combined with heavy investment costs for new local, online and wireless services. The market did not take the news lightly against the confusing backdrop of telecommunications reform and the break-up of the phone behemoth into three parts -- the "new" AT&T Corp., LUCENT TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %> and NCR.

The drop does not affect the impending spin-off of AT&T's 82.4% holding of Lucent Technologies. Given that there is approximately 0.325 shares of Lucent for each share of AT&T, or $12 3/4 at today's price, the "new" AT&T Corp. and NCR are jointly trading at $38 7/8. If you annualize reduced earnings expectations for the second half, this puts the combined company at about 12.0 times earnings.

WHAT HAPPENED TO THE STOCKS?

Shares of AT&T dropped $5 1/2 in midafternoon trading, falling to $51 5/8. The shares were within a hair's distance of the long-distance giant's 52-week low of $49 1/4. Shares of Lucent Technologies dropped $1 1/8 to $39 3/8 in the wake of the news.

Transmitted: 9/24/96

(FOOL EQUITY RESEARCH)
By Dale Wetlauffer (MF Raleigh

ALEXANDRIA, Va., September 24, 1996/FOOLWIRE/ --- Why did AT&T go down today? A trip back to AT&T's last 10-Q finds one its standard boilerplate statement: "These forward-looking statements are subject to a number of uncertainties and other factors...that could cause results to differ materially from such statements." The earnings warnings released this morning result directly from many of the factors that were enunciated after that statement in the 10-Q.

TELECOMMUNICATIONS REFORM EATS PROFITS. Several of the factors directly relate to the implementation of the 1996 Telecommunications Act, which directs LECs (local exchange carriers -- the "Baby Bells" or others) to re-sell to AT&T access to their customers at "meaningful discount rates." AT&T today published multiple press releases announcing the beginning of arbitration in a number of states, including Pennsylvania and Colorado. In these hearings, AT&T will ask for discounts from companies such as US WEST <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: USW)") else Response.Write("(NYSE: USW)") end if %> and GTE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GTE)") else Response.Write("(NYSE: GTE)") end if %>. In negotiations to this point, the discounts offered by these companies have not satisfied AT&T.

BREAKING UP LOCAL MONOPOLIES. While there has been competition in the long-distance markets since the breakup of the Bell System, many local markets have operated under monopolistic conditions. AT&T argues that during that time, prices for long-distance services have deflated much more quickly than for local telephone services. Under that reasoning, the long-distance phone companies want to prosecute the conditions of the Telecommunications Act and get into the local loop at prices that will allow them to make a profit. AT&T, MCI, and Sprint want a piece of that huge and currently inefficient (in their opinion) pie. At the same time, they want to boost revenues and leverage their current asset base in preparation for more competition in the long-distance arena.

ARBITRATION COSTS MONEY. To that end, one can imagine how going forward with extensive efforts to open the local loop would hurt earnings in the coming quarters. In his letter to AT&T's shareholders this morning, Chair Robert Allen warned that earnings for the third quarter would come in 10%, or about $0.09 per share, below estimates of $0.92 per share on continuing operations. On 1.6 billion shares outstanding, that's a $161 million shortfall. Arbitration in all of the local access markets is going to be a highly expensive effort. But this cannot account for the entire $161 million shortfall.

INCREASE COMPETITION DOESN'T HELP. The rest of deficit will come from intensified competitive pressures in the long-distance and wireless arenas. In long-distance, the company recently announced that it would offer 15 cents/minute anytime -- anywhere long-distance service. As hard as it is for companies to do, lowering the price of something oftentimes increases units sold. If they have their costs in-line, that will move them down their cost curve to the point where they can offer a higher amount of services for a lower price per unit. While it all sounds great in theory, the transition is always the tough time. In addition, the company has pointed to the roll-out of its online service, AT&T Worldnet, as being a destination for some of the money that will not be flowing to the bottom line. As any AMERICA ONLINE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %> or NETCOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NETC)") else Response.Write("(Nasdaq: NETC)") end if %> shareholder can tell you, it is extremely expensive to roll out and operate a service, even when the company does own significant portions of its network. The promotional costs, depreciation, and operating costs based on flat-pricing schemes are not likely to be covered until the audience matures into the eight digit range.

PROMOTIONAL COSTS INCREASE. At the same time that the company is incurring SG&A expenditures to get into the local loop and stepping up investments in newer media, its core services are experiencing pressures from expense side of the earnings equation. While the company moves to flat pricing, it incurs enormous costs to attract and retain customers. Buying thousands of minutes per quarter in television and other advertising, sending out checks to invite customers back to AT&T, and absorbing the costs of switching customers' accounts to and fro all take their toll on the bottom line. As PROCTER & GAMBLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %> has discovered, it may be more profitable to offer fewer products and cut down on the promotional costs, as it is doing with its phase-out of coupons. By moving away from the tired old game of playing "customer tennis" with MCI <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> and SPRINT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FON)") else Response.Write("(NYSE: FON)") end if %>, AT&T hopes to free up cash flow to invest in other, more worthwhile pursuits.

AT&T AT A CROSSROADS. In the end, AT&T stands at a crossroads in the telecommunications business, much as it did when the Bell System was broken up. The company is heavily weighted toward lower-margin customer long-distance business while competitors like MCI are surging ahead in ATM, frame relay, and other services which are well suited to their newer and lower-depreciation fiber network. In addition, while AT&T has to recover its investment in McCaw Communications, MCI is reselling the wireless services of other companies who have to recover their costly capital expenditures. Without spending extensively on the types of infrastructure that become outmoded and uncompetitive, MCI is more nimble than the giant AT&T.

ALL IS NOT LOST. While earnings may fall short of expectations at AT&T, it's not as if they aren't making money. They just need to adjust to the economics of the marketplace in the 90s. The local exchange monopoly offers AT&T a large opportunity right now. Dollars spent today, which may reduce current earnings, are seen as an investment that will benefit future periods. Strategic shifts are also investments, in that any bumpiness experienced today is hoped to be felt in smoother, more profitable performances in the future.

* A Fool Take represents the opinion of one Fool and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Fool's thoughts.

Transmitted: 9/24/96