AT&T's Troubling Trends

At first glance, third-quarter results from telecom giant AT&T (T) appear strong. The Dallas-based phone service provider posted net income of $3.23 billion, or 55¢ a share, a 5.5% increase from $3.06 billion, or 50¢ a share, a year earlier. Revenue gained 4%, to $31.3 billion, led by a notable 15.4% increase in wireless sales. To boot, the wireless business logged a whopping 2 million net new customers, giving AT&T nearly 75 million subscribers nationwide.

But troubling signals lie just beneath the surface. Customers are disconnecting phone lines at an alarming rate. Too few are signing on for broadband connections, and though the number of new wireless subscribers is impressive, AT&T's wireless margins are getting squeezed. All of this comes in the face of a weakening economic outlook that's forcing consumers to cut household budgets and banks to rein in lending. Worried shareholders traded AT&T stock down 7.6%, to about 23.78, after the results were released on Oct. 22. "The market is telling you there is a lot of risk out there for AT&T," says Timothy Horan, an analyst for Oppenheimer & Co.

And what's risky for AT&T may prove just as ominous for the rest of the telecom sector. Analysts expect Verizon Communications (VZ), Sprint (S), and other phone service providers to show similar signs of weakness when they report results in the coming days. In fact, AT&T is something of a proxy for the broader economy. As a huge provider of services to major businesses, AT&T's customer list contains businesses of every stripe. It is instructive that the carrier's enterprise services unit saw sales dip 1.4% from a year ago. "That is troubling as you head into the teeth of the recession," says Sanford C. Bernstein analyst Craig Moffett, who adds that the view of AT&T's financial future right now is "as clear as mud."

Existing strains in AT&T's local-phone business were accentuated in the third quarter. The number of consumer voice lines in service fell 10.5%, to 28.33 million, from a year ago. Things are not much better in the broadband arena. Last year at this time, AT&T added nearly 500,000 digital subscriber lines. This year, it added 148,000, a decline of more than 70%. "These are obviously challenging times," AT&T Chief Financial Officer Rick Lindner said on an Oct. 22 conference call with analysts.