Don't Hang Up on AT&T

INVESTORS SHOULD PUT AT&T BACK ON THEIR SPEED-DIAL LISTS.

The country's No. 2 cellular phone-service provider's shares (T) are down 8% this year, while the Dow Jones Industrial Average -- made up of AT&T and 29 other blue-chip stocks -- is up 17% over the same period. The broader Standard & Poor's 500 index, to use another comparison, has gained a whopping 21%.

"Since March, the market has been enamored with leverage and low quality," says Charlie Smith, chief investment officer of the value-oriented large-cap mutual fund Fort Pitt Capital Total Return (FPCGX), with $31.2 million in assets, including top holding AT&T, at 4.66%. "Stable companies haven't performed well," says Smith.

In AT&T's case, the woeful share performance is also attributable to the approaching end of its exclusive contract to sell Apple's (AAPL) wildly popular iPhone, says Mike McCormack, telecom analyst at JPMorgan. Although the terms of their deal are confidential, it's widely assumed that it will wind up toward the end of 2010. The loss of that exclusivity could have a "meaningful" impact on AT&T's subscriber base, he says.

Yes, it could. But AT&T's weak share price overlooks a number of positives -- including robust cash flow, a 6.3% dividend yield, a broad line of other smartphones and a management team, headed by CEO Randall Stephenson, that has proved it can cut costs, reduce debt and integrate acquisitions. For many of the same reasons, some analysts also recommend buying AT&T debt.

"The loss of exclusivity in 2010 is already priced into the stock," says Sergey Dluzhevskiy, telecom analyst at Gabelli & Co. However, there'll be some headline risk when the actual event occurs. AT&T enjoyed a 2.2% gain in average revenue per wireless user in the third quarter, and had a record low churn, or customer-loss rate, of 1.43% in the same period, he notes. Dluzhevskiy believes the stock, at 26.11 last Thursday, is worth 34, based on 2009 results. At recent levels, the stock has a price/earnings ratio of just 12 times estimated 2010 earnings. Gabelli & Co. has a Buy on the shares.

THE KEY BENEFIT OF THE iPhone contract has been in "getting people into the store and [helping] sell other smartphones" for AT&T Wireless, says Todd Rosenbluth, an analyst at Standard & Poor's Equity Research, which has a Strong Buy rating on AT&T and a 12-month price target of 31. "It helped to boost and invigorate its customer base," as 60% of iPhone sales and subscriptions went to existing AT&T customers, he says.

These advantages are unlikely to disappear completely, even if the contract expires next year.

"We've got a good relationship with Apple," declares Rick Lindner, chief financial officer at AT&T. "At some point in the future, if Apple wants other U.S. carriers to sell the iPhone, we expect we'd continue to sell a full line of Apple products," he says. And "we have a very robust line of devices, including higher-end, integrated devices," Lindner adds.

Aside from the iPhone, AT&T is the leading service provider for BlackBerry, and offers a variety of smartphones including hotties like HTC Pure, Samsung Impression and LG Vu, among others.

AT&T added a record 2 million wireless subscribers in the third quarter, the third time in the last five quarters it's approached that number, embarrassing bearish Wall Streeters who warned of flattening demand. In all, AT&T has 82 million wireless customers, behind No. 1 Verizon Communications' (VZ) 89 million.