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					                                 AT&T Inc.
Investment Recommendation
                                 Selection Criteria:
        Moderate Buy
      20 shares @ $32.18         This stock was to be selected within the technology
     Stop-Loss     $26.00        industry with respect to the goals of the Mizzou
     Take Profits $40.00         Investment Fund. AT&T is a large cap firm with a beta
                                 of less than 1.5. The firm has growth potential and has
Pricing (as of 10/09/06)         shown a consistent increase in dividends paid allowing
Closing Price      $32.18        AT&T to fit into the desired “value” category.
52 Week High $33.76
52 Week Low $21.79               I chose to go with a firm within telecommunications as
                                 opposed to information technology due to state of our
Valuation                        current portfolio. IT represents 15.87% of our portfolio
FY (Dec)    EPS (dil.)    P/E    (9.5% desired) whereas telecom represents 1.19% (1.5%
2004        1.45         19.60   desired). While Cerner is in the „health care information
2005        1.30         17.66   technology‟ business, splitting Cerner between health
TTM          1.68        19.18   care and IT in our portfolio still leaves us with over 10%
                                 invested in IT.
Profitability & Effectiveness
(ttm)
ROA                   5.18 %     Company Information:                       k                  %
ROE                  12.83 %
Profit Margin        11.21 %     AT&T Inc. (NYSE: T) is the largest provider of both
Operating Margin     16.55 %     local and long distance telephone services, wireless
                                 service (60% position in Cingular), and DSL internet
Market Data                      access in the United States. The current company, which
                                 is based in San Antonio, Texas, was formed in 2005 by
Total Assets      145.632 B      SBC Communications' purchase of its former parent
Market Cap        124.990 B      company, AT&T Corp. (see image below). As a part of
Avg. Volume (3m) 17,424,900      the merger, SBC shed its name and took on the iconic
                                 AT&T moniker.
GICS Sector
Telecommunication Services       AT&T offers a broad spectrum of telecommunication
                                 services: Voice line, Frame Relay, DSL Internet, Dial Up
                                 Internet, Voice over Internet Protocol (VoIP), local and
                                 long distance calling, as well as directory services
                                 (YellowPages). Recently the firm has moved into
                                 bundled services as well as working with cell phone
                                 plans. AT&T serves millions of customers around the
                                 world in 240 countries and territories.

                                 For 2006, AT&T was ranked 39th in the Fortune 500.
                                 The magazine also named AT&T the America‟s Most
Ryan C. Stoll                    Admired Telecommunications Company and the
rcskr4@mizzou.edu                World‟s Most Admired Telecommunications Company.



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Currently, AT&T is:
     No. 1 in the U.S. consumer market, serving local, long distance, DSL broadband, and
           wireless.
     No. 1 DSL broadband, delivering advanced IP-based solutions to residential and small
           business customers – 7 million lines in service
     No. 1 Wireless provider in the U.S. – 54 million customers (through Cingular)
     No. 1 in the U.S. and is a global leader in delivering traditional and IP-based
           communication services to businesses
     No. 1 Directory publisher worldwide – 110 million directories per year




On March 5th of 2006, AT&T announced plans to acquire BellSouth for $67 billion which would
allow for the consolidation of ownership of Cingular Wireless (BellSouth currently owns the
remaining 40%). The Federal Communications Commission will vote on the merger on October
12th, 2006.


Industry:

Per Yahoo! Finance, AT&T is included in the Technology Sector and further within the Telecom
Services – Domestic industry. AT&T is the industry leaders in market capitalization (1/32) and


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revenue growth (2/32). Its long-term growth rate (3/32) and EPS growth (9/32) are also
respectable. AT&T‟s higher P/E ratio (5/32) can be concerning however expected growth may
warrant the price premium. AT&T finds itself either near the top or the middle of the domestic
telecom industry with regard to the following statistics:




Competition:

AT&T has stiff competition from Sprint Nextel and Verizon, the other main telecommunications
players. Each company has recently gone through significant mergers to improve their position.




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If it successfully acquires BellSouth (market cap of 77B and revenues of 20.7B), AT&T would
dwarf its nearest competitor (Verizon) in size.


Performance vs. The Market:




Valuation:

To evaluate AT&T, the dividend discount model can be applied. A risk-adjusted discount rate
must first be determined via the capital asset pricing model, RE = RF+ β (Market Risk Premium).
Using a β of 1.08 (Average of Yahoo!, Reuters, MSN Money, and Google), a risk-free rate of
4.81% and an expected market – S&P 500 – return of 9.03% (as recommended by the Portfolio
Committee), the following rate is determined:

      RE = 4.81 + 1.08 ( 9.03 – 4.81 ) = 9.368%

The divided discount model for standard growth, PE = Div / (RE – G), takes into account any
anticipated growth in dividends paid. Over the past five years, AT&T has averaged a dividend
increase of 6.8%. The expected annual dividend to be paid is $1.33 per share.

      PE = 1.33 / ( .09368 – .068 ) = $51.79

To better verify this estimate, I used Damodaran‟s Gordon Growth Model:




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The owner earnings model can also be used for a valuation of AT&T. Using the previously
determined discount rate of 9.37%, an analyst estimated 9% first stage growth rate, a




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conservative 3% second stage growth rate and owner earnings from 2005, the following intrinsic
share value is determined:

Owners' Earnings Discount Model
assuming discount rate (k) of                                               9.37%


Owner Earnings in 2005:
Net Income                                             $     4,786,000,000.00
Depreciation & Amortization                            $     7,622,000,000.00
Capital Expenditures                                   $    (5,576,000,000.00)
Owner Earnings                                         $     6,832,000,000.00


                                                                         2005                   2006                  2007
Prior Year Owner Earnings                              $      6,832,000,000.0       $ 7,446,880,000.0   $ 8,117,099,200.0
First Stage Growth Rate (add)                                            9.0%                   9.0%                  9.0%
Owner Earnings                                         $      7,446,880,000.0       $ 8,117,099,200.0   $ 8,847,638,128.0
Discounted Value per annum                                    $7,446,880,000.0       $7,421,822,836.7      $7,396,849,985.3


                2008                         2009                      2010                     2011
 $ 8,847,638,128.0          $ 9,643,925,559.5          $ 10,511,878,859.9        $ 11,457,947,957.3
               9.0%                          9.0%                      9.0%                     9.0%
 $ 9,643,925,559.5          $ 10,511,878,859.9         $ 11,457,947,957.3        $ 12,489,163,273.4
  $7,371,961,162.3                $7,347,156,084.9          $7,322,434,471.3         $7,297,796,040.6


                  2012                         2013                      2014
 $ 12,489,163,273.4           $     13,613,187,968.0       $ 14,838,374,885.1
                  9.0%                         9.0%                      9.0%
 $ 13,613,187,968.0           $     14,838,374,885.1       $ 16,173,828,624.8
     $7,273,240,513.0               $7,248,767,609.5          $7,224,377,052.1


Sum of present value of owner earnings                     $73,351,285,755.8


Residual Value
Owner Earnings in year 10                              $     16,173,828,624.8
Second Stage Growth Rate (g) (add)                                      3.00%
Owner Earnings in year 11                              $     16,659,043,483.6
Capitalization rate (k-g)                                               6.37%
Value at end of year 10                                $ 261,605,582,342.30


Present Value of Residual                                  $106,842,564,610.30
Intrinsic Value of Company                                 $180,193,850,366.05


Shares outstanding assuming dilution                             3,913,290,000
Intrinsic Value per share                                               $46.05




Prices of $51.79, $53.81, and that of $46.06 from the above models suggest that AT&T is
currently undervalued.



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Financial Ratios:




        Although AT&T does not have a great deal of liquidity (see quick and current ratios),
         neither does the telecom industry.
        AT&T has a lower debt to equity ratio when compared to the industry, offering less risk
         to its shareholders if the company were to go bankrupt for some reason.
        AT&T‟s operating margin and especially its net profit margin are higher than the industry
         average. AT&T is above average in terms of its profitability.


Risks:

        Pending class action lawsuit alleging AT&T had allowed National Security Agents to
         monitor phone and internet communications of AT&T customers without warrants. If



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        true, would violate the Foreign Intelligence Surveillance Act of 1978 as well as the First
        and Fourth amendments of the U.S. Constitution.
       Power of buyers increasing. Telecommunications firms are faced with pricing wars due
        to relatively similar service between competitors. Nearly everyone has phone service
        already, so competitors are forced to lure customers with lower prices and more
        „exciting‟ services.
       Threat of substitutes. Cable TV (offering broadband) and satellite operators (high-speed
        business networking needs) are now competing for buyers.
       Rapidly changing technology. In this industry, advances are quickly being made (see
        VoIP, wireless broadband, etc.). Being a step ahead of the game is important in order to
        remain competitive.


Analyst Ratings:

Zacks average brokerage recommendation is Hold.




  *Note: 2.0 would be classified as a Moderate Buy.




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Recommendation:

Based on the following:
    Decent financials
    Polarized analyst ratings moving towards „buy‟
    Solid expected growth (9.5% over the next five years compared to 6.19% industry avg.)
    65% of shares held by institutions and mutual funds
    Recently increased synergy realization from AT&T / SBC merger
           o Up 20% to $18 billion
    Likely BellSouth acquisition by end of 2006
    Falls into the goals of the Mizzou Investment Fund

I recommend we purchase 20 shares of AT&T at $32.18. This would bring our current
investment in telecommunications to right at 2% (desired 1.5%).




References:
    finance.yahoo.com
    www.AT&T.com
    www.zacks.com
    moneycentral.msn.com
    www.reuters.com
    www.morningstar.com
    www.wikipedia.org



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Appendix: Financial Statements (Source: zacks.com)




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