AT&T rallied Monday after Paul Singer's Elliott Management announced it owns $3.2 billion in the underperforming telecom giant's stock and said in a letter that it hopes to help the company trim unneeded assets.
The hedge fund said it sent a letter to the company's board and argued for ways AT&T can "improve its business and realize a historic increase in value."
The activist investor said its AT&T stock purchase is one of the firm's largest investments ever. Elliott also believes that AT&T CEO Randall Stephenson's exit is on the table and thinks that the telecom company will engage and settle soon, people familiar with the situation told CNBC.
Elliott said the company could eventually be worth at least $60 per share, catapulting the stock up as much as 9% in premarket trading Monday. The stock trimmed its gains after the opening bell, rising 1.4% on Monday to finish the day at $36.77. The stock closed at $36.25 on Friday.
"The purpose of today's letter is to share our thoughts on how AT&T can improve its business and realize a historic increase in value for its shareholders," the memo says. "Elliott believes that through readily achievable initiatives — increased strategic focus, improved operational efficiency, a formal capital allocation framework, and enhanced leadership and oversight — AT&T can achieve $60+ per share of value by the end of 2021."
"AT&T has been an outlier in terms of its M&A strategy: Most companies today no longer seek to assemble conglomerates," the fund added. "We firmly believe that AT&T's M&A strategy has not only contributed directly to its profound share price underperformance, but has also caused distractions that have contributed to the Company's recent operational underperformance."
The Elliott team raised concerns about AT&T's recent acquisition of Time Warner in particular, warning that "AT&T has yet to articulate a clear strategic rationale for why AT&T needs to own Time Warner.
In response to the hedge fund's letter, AT&T said its management team and Board of Directors "maintain a regular and open dialogue with shareholders and will review Elliott Management's perspectives in the context of the company's business strategy."
"We look forward to engaging with Elliott. Indeed, many of the actions outlined are ones we are already executing today," AT&T said in a statement. "AT&T's Board and management team firmly believe that the focused and successful execution of our strategy is the best path forward to create long-term value for shareholders."
But Elliott's new stake, as well as its doubts about Time Warner, drew praise from President Donald Trump, a longtime critic of the CNN parent.
"Great news that an activist investor is now involved with AT&T. As the owner of VERY LOW RATINGS @CNN, perhaps they will now put a stop to all of the Fake News emanating from its non-credible 'anchors,'" Trump wrote. "Also, I hear that, because of its bad ratings, it is losing a fortune ... But most importantly, @CNN is bad for the USA."
Trump has long had a strained relationship with the press, and with CNN in particular. The president earlier this year called for a boycott of AT&T to force "big changes" at its CNN subsidiary, which Trump often accuses of biased and negative coverage.
AT&T's $85 billion purchase of Time Warner represents one of the largest acquisition in dealmaking history and in general has been applauded by proponents as a solid investment in some of the globe's top media assets. Critics, however, note that the combined company would be responsible for some $180 billion in debt, a 12% jump from AT&T prior load.
"While it is too soon to tell whether AT&T can create value with Time Warner, we remain cautious on the benefits of this combination," the letter read. " We aren't alone in our cautious outlook — Jeff Bewkes, the CEO who sold Time Warner to AT&T, recently referred to the vertical integration of content and distribution as a 'fairly suspect premise.'"
In addition to the concerns surrounding debt load and Time Warner, Elliott's letter makes five key points:
"We've been frustrated for a long time with AT&T stock. Like Elliott, in certain parts of the business, we've seen the potential there for years," said Jonathan Chaplin, an analyst at New Street Research. "We just despaired of it ever being captured under this management team with the strategy they've deployed up until now."
"If I was in the corner office of AT&T today, to be honest, I'd be looking at breaking up the company back into its three constituent parts," he added. "I honestly don't believe that there are synergies between the wireless business, the TV distribution business and the media business."
Activist investors like Elliott take stakes in what they believe are undervalued companies and then agitate for change. Such demands can range from mixing up corporate strategy to replacing management teams and board members. Unlike peers, Elliott has the size and influence to buy entire companies instead of pushing for changes as a minority stakeholder.
Elliott has offered to buy multiple companies since founding a private-equity arm in 2015. In 2017, the hedge fund disclosed a 9.2% stake in health-care technology Athenahealth, which in November it agreed to purchase for about $5.5 billion.
Within the past year, sources confirmed to CNBC that it was nearing a deal on a leveraged buyout for $11 billion Arconic.
The firm called its move the "Activating AT&T Plan" saying, "AT&T can unlock significant value by focusing its asset portfolio, improving operational performance, instituting clear capital priorities, and enhancing leadership and oversight."
Here is the full letter from Elliott to AT&T:
September 9, 2019
The Board of Directors
208 South Akard St.
Dallas, TX 75202
Attn: Chairman Randall Stephenson
Attn: Lead Director Matthew Rose
Dear Members of the Board:
We are writing to you on behalf of Elliott Associates, L.P. and Elliott International, L.P. (together, "Elliott" or "we"). Elliott owns $3.2 billion of the common stock and economic equivalents of AT&T Inc. (the "Company" or "AT&T"). The large scale of our investment reflects our deep conviction in the extraordinary value opportunity realizable at AT&T today.
AT&T is unquestionably one of the world's most important companies and one of America's proudest technological stories. Nearly 150 years after its founding, AT&T remains a vital steward of global infrastructure, serving more than 370 million direct-to-consumer relationships and employing more than 250,000 people across virtually every country in the world. There is a great deal at stake in ensuring that AT&T realizes its potential – for shareholders, for consumers, for employees, and even for the U.S. as a global telecom leader.
It is through this lens that Elliott approaches its investment in AT&T. Though it is outside the scope of this letter to detail AT&T's rich and pioneering history, we want to make clear that Elliott has tremendous respect for the Company's legacy, as well as for the hard work, ingenuity and passion of its dedicated employees, who work tirelessly to ensure our world remains connected.
The purpose of today's letter is to share our thoughts on how AT&T can improve its business and realize a historic increase in value for its shareholders. Elliott believes that through readily achievable initiatives – increased strategic focus, improved operational efficiency, a formal capital allocation framework, and enhanced leadership and oversight – AT&T can achieve $60+ per share of value by the end of 2021. This represents 65%+ upside to today's share price – a rare opportunity for any company, let alone one of the world's largest.
Our letter today is organized as follows:
Elliott looks forward to working collaboratively with the AT&T team to act on this opportunity and realize the Company's full potential.
Elliott's Investment in AT&T
Elliott is an investment firm founded in 1977 that today manages approximately $38 billion of capital for both institutional and individual investors. We are a multi-strategy firm, and investing in the Technology, Media and Telecom (TMT) sector is one of our most successful efforts.
Elliott's approach to its investments is distinguished by our extensive due diligence, and our efforts on AT&T have followed this same approach. We enlisted former executives, industry experts, investment bankers, lawyers, accountants and consultants in an exhaustive diligence effort spanning AT&T's numerous businesses. Selected examples of our efforts include:
We believe that this time- and resource-intensive exercise has given us a thorough understanding of the Company's existing strengths and opportunities for improvement. It is important to emphasize that the observations made below regarding the Company's recent strategic and operational decisions are drawn directly from this wide-ranging diligence and reflect broadly shared views on AT&T's recent history and required future direction. We have carefully tested the views of others against our own, and we are convinced that the resulting recommendations will both maximize shareholder value and best position AT&T for long-term success.
What has attracted our attention, as well as the attention of other shareholders – from large institutions to individual AT&T employees – has been the prolonged and substantial underperformance of AT&T as an investment relative to its potential. Over the past ten years, for example, AT&T – a "bellwether" in all senses of the word – has not only failed to keep pace with the broader market, but has actually underperformed by over 150 percentage points:
Click the following link to view AT&T's Share Price Performance – Last Ten Years: https://activatingatt.com/image1.
This underperformance also holds for AT&T's Total Shareholder Return ("TSR", stock price plus dividends). Over the past decade, AT&T's TSR has lagged the S&P 500's TSR by well over 100 percentage points. In fact, AT&T's underperformance has been so severe and disappointing that it was dropped from the Dow Jones Industrial Average in 2015, an index that has included AT&T and its predecessors since 1939.
Unfortunately for shareholders and the millions of current and former employees who own shares in AT&T as part of their remuneration or pension, this underperformance has been both profound and persistent. AT&T's TSR has underperformed across all relevant benchmarks and timeframes for more than 10 years, with the exception of a small catch-up over the last year following the Company's 27% share price decline in 2018 and coinciding with Elliott's large purchases of stock.
Click the following link to view Relative Total Shareholder Return: https://activatingatt.com/image2.
As you can see, AT&T has been a disappointing investment for its shareholders relative to nearly any benchmark.
How We Got Here
Below, we briefly summarize the business issues that have led AT&T to its current state, which we categorize into two groups: I) Strategic Setbacks and II) Operational Underperformance. We welcome the opportunity to share more detailed thoughts on these topics in our conversations with the Board.
I. A Series of Strategic Setbacks
To fully appreciate the significance of the Company's decisions and to contextualize them appropriately, we think it useful to revisit how AT&T first found success.
Originating in 1984 as the smallest of the Baby Bells, Southwestern Bell (later renamed SBC) quickly embarked on an aggressive yet focused strategy of growth and execution. Under the famed stewardship of Ed Whitacre, SBC radically transformed the country's wireline and wireless industries. Over the decade between 1997 and 2007, SBC acquired Pacific Telesis, Southern New England Telephone, Ameritech, Comcast Cellular, AT&T Wireless, BellSouth and, of course, the AT&T Corporation. In doing so, the now re-named AT&T became the nation's largest telecommunications company.
Whitacre's strategy was successful – the Company had a clear strategic rationale for the assets it acquired and a plan to execute across the business as a whole. The results, too, differed from AT&T's current situation: From 1984 through Whitacre's retirement in June 2007, AT&T shares returned over 2,000%, handily outpacing the results of either the S&P 500 or AT&T's primary competitor, Verizon. On the day Whitacre retired, AT&T's stock price closed at $40.53, a level it remains below today.
In recent periods, however, AT&T has embarked upon a very different sort of M&A strategy. Over a series of deals totaling nearly $200 billion, AT&T built a diversified conglomerate by pushing into multiple new markets. In each case, the push was as significant as possible. Beginning the decade as a pure-play telecom company with leading wireless and wireline franchises, AT&T has transformed itself into a sprawling collection of businesses battling well-funded competitors, in new markets, with different regulations, and saddled with the financial repercussions of its choices:
These three transactions are not the only examples of AT&T's recent questionable M&A – the push into the Mexican wireless market, for example, has also severely underperformed expectations – but they are the largest and most damaging.
As long-time followers of Time Warner, we see a contrast between AT&T's M&A strategy and that of Time Warner under Jeff Bewkes: When Bewkes took over Time Warner as CEO, he inherited a sprawling company with numerous related but non-core assets – AOL, Time Warner Cable, a collection of publishing assets and other smaller businesses. He then spent the following decade divesting the non-core assets in order to focus on Time Warner's leading content franchises. This strategy paid off: Time Warner became both a flourishing media enterprise and a strong investment, returning more than double the S&P 500's ~140% return during Bewkes' 10-year tenure.
AT&T has been an outlier in terms of its M&A strategy: Most companies today no longer seek to assemble conglomerates. This approach is more characteristic of a prior era, calling to mind the Conglomerate Boom of the 1960s or the Mike Armstrong years at the "old" AT&T. It also represents a departure from the approach articulated in 2007 by the Company's Chairman and CEO at his first analyst day after being named to that position: "When there's a temptation to want to launch off into areas that may not be closely tied to our strengths or which are going to distract us from an operational focus, that won't happen."
We firmly believe that AT&T's M&A strategy has not only contributed directly to its profound share price underperformance, but has also caused distractions that have contributed to the Company's recent operational underperformance.
II. Operational Underperformance
In his final letter to shareholders in AT&T's 2006 annual report, Whitacre opened by saying "AT&T is a company with a tradition of delivering on our promises." During the last decade, however, AT&T has not delivered on its promises, as its radical transformation through M&A has coincided with deteriorating operational performance. As Moffett Nathanson summarized: "The decline in AT&T's shares over the last few years has been more than just a referendum on strategy. It has also been a direct reflection of a steady decline in AT&T's operating performance."
Poor Execution in Wireless
When AT&T (then-SBC) acquired AT&T Wireless in 2004 through its Cingular Wireless joint venture, it became the nation's largest wireless provider. AT&T had every right – if not a mandate – to execute well and expand its lead. Unfortunately, AT&T consistently fell behind, as competitors delivered on network quality commitments, executed on new technology deployments and innovated with disruptive offerings.
Some examples help illustrate this underperformance:
The primary consequence of these setbacks and others has been a consistent ceding of market share. In the last decade, T-Mobile has grown its share of the "Big 4" wireless revenues by ~600 basis points while AT&T's share has shrunk ~400 basis points, making it the worst performer of the group.
Click the following link to view Cumulative Change in Relative Wireless Market Share by Revenue for Top Four Competitors: https://activatingatt.com/image3.
Fortunately, the ongoing 5G transition presents AT&T with a renewed opportunity to reset the wireless narrative and reclaim market leadership. AT&T today is in prime position to be the early market leader in 5G given its premier spectrum positioning, early LTE-Advanced work and recent network improvements (driven by the FirstNet build and its one-touch strategy).
We believe AT&T will be able to quickly move forward while its main competitors remain either spectrum-disadvantaged or distracted as they integrate major transactions. However, while AT&T is well positioned, success in 5G will require meaningful investment and improved execution; anything less and AT&T risks missing this opportunity and falling behind again.
Beyond the wireless issues detailed above, AT&T has suffered from product issues in other business units that have hampered its ability to remain competitive:
Click the following link to view AT&T Television Subscribers Since 2016 (in millions): https://activatingatt.com/image4.
Although these two recent examples are top-of-mind, they are not the only ones. Despite more than $4 billion in M&A and an even greater amount committed to ongoing investment, AT&T's wireless operations in Mexico remain unprofitable and below expectations. The Digital Life home security product, highlighted in 2012 as a new and exciting "billion-dollar opportunity," never lived up to expectations. Meanwhile, numerous other initiatives (mobile wallet, internet security, connected car, unified communications, hosting and many more) failed to take off. Even the overall broadband and video deployments merit scrutiny: Misjudging consumer demands for broadband speeds has rendered the original Fiber to the Node (FTTN) deployment suboptimal, while the losses at U-Verse served as a justification for the ill-timed acquisition of DirecTV.
Retention and Leadership
Beyond these execution challenges, AT&T has also struggled with human capital issues, including talent retention, recruitment and leadership more broadly. For example, almost immediately after AT&T completed its DirecTV acquisition, the entire DirecTV management team departed. These exits were cause for concern given that DirecTV was a scale asset (~$35 billion sales and 30,000 employees) operating a different technology in a television market where AT&T (through its nascent U-Verse offering) had limited experience. One can't help but wonder whether AT&T's difficulties at DirecTV were compounded by this lack of management continuity and experience.
Click the following link to view DirecTV Leadership at Time of Acquisition: https://activatingatt.com/image5.
WarnerMedia has similarly suffered from alarming executive turnover, a particularly troubling pattern given the very different nature of its businesses compared to those in which AT&T has historically operated. AT&T rightfully praised Time Warner's leadership and cited its creative talent as one of the primary reasons to pursue the transaction: "The big part of the value of this transaction is Time Warner's outstanding leadership team," and "they are going to be very critical to the success of this business going forward." Yet just over a year after closing the transaction, almost all of Time Warner's former leadership has left. For a content business now owned by a telecommunications company and under the direct supervision of a lifelong telecom executive, this lack of continuity in leadership presents a real concern for investors and should be a key focus for the Board.
Click the following link to view Time Warner Leadership at Time of Acquisition: https://activatingatt.com/image6.
Moreover, there are growing concerns about the depth of leadership even within AT&T's core businesses. These fears were very recently highlighted by the announced (and surprising) departure of the CEO of AT&T Communications – a collection of wireless, wireline and entertainment assets which account for ~80% of the entire Company's sales. To put this in context, the executive who departed ran a division more than 25% larger than Comcast and roughly twice as large as Disney. Instead of conducting a thorough search for the most qualified executives available, AT&T decided to wait a week and then announce that the recently installed CEO of WarnerMedia – itself a massive and very different business that clearly requires a full-time manager – would now also be responsible for an additional $145 billion of revenue as the President and COO of the entire Company.
Given the critical juncture at which each of AT&T's businesses stands today, improving its approach to recruiting, retention, succession and governance must be a key priority for management and the Board.
The Result: A Challenged Financial Narrative
The Strategic Setbacks and Operational Underperformance discussed above have weighed heavily on the financial performance of the Company and on the ability of its executives to manage it. In retrospect, this is unsurprising – not only did AT&T engage in a massive transformation of its asset mix, but it did so with breathtaking speed. In just a matter of years, AT&T bought its way from a pure-play wireless and wireline business to what it today calls a "modern media company." By contrast, its closest peer, Verizon, pursued the opposite path by reducing its wireline footprint and doubling down on the strong wireless market.
Click the following link to view Portfolio Evolution – 2010 to Today: https://activatingatt.com/image7.
The picture above tells this story and also helps frame why AT&T is such a challenging business to manage and understand – both for its managers and for its shareholders. For its managers, each of the business units is extremely complex in and of itself, competing against large and well-funded competitors in rapidly changing landscapes, some in areas where AT&T has neither history nor expertise. Moreover, it is competing in these arenas on the largest scale possible: Each of these "business units" is either the first- or second-largest player in its industry, and each of AT&T's four primary business lines would be a large-cap company on its own. It makes sense that companies today no longer "diversify" as they did decades ago: Managing this level of change, this quantity of integration and this degree of competition is almost always value-destructive. As Morgan Stanley astutely cautioned at the time of the Time Warner deal:
"Challenging execution: One of our major concerns with any Telecom M&A deal is when the companies move too far from their core business at a time when many of AT&T's existing businesses are facing secular challenges. The telecom industry has many examples of deals which failed to reach their potential, or destroyed significant value, including investments in content."
The lack of focus has affected AT&T's performance and its management's ability to live up to expectations – both internally and externally. For example, analyst expectations for AT&T's earnings have declined precipitously and consistently since 2016 – almost in a straight line as the Company's performance has proved disappointing. In fact, as many have observed, both AT&T's actual 2018 EBITDA and analyst expectations for its 2019 EBITDA are now lower than they were at the start of 2016, despite AT&T's subsequent acquisition of a ~$110 billion company.
Click the following link to view Evolution of Consensus EBITDA Expectations Since 2016: https://activatingatt.com/image8.
For AT&T's managers and the Board charged with overseeing them, missing expectations by this magnitude may cause concern that the team does not have a handle on the business. Worse still, it calls into question whether the managers have the operational capability necessary to track and steer the complex companies under their watch. Given the scale of change that has taken place, such difficulties would not be surprising.
For shareholders, however, this complexity and its attendant challenges have yielded profoundly negative results. It is hard enough for shareholders to evaluate AT&T today – compared to Verizon, Disney, Charter and even Comcast, understanding AT&T's collection of businesses is a daunting challenge. When one adds to this complexity the prospect that management may be overwhelmed and its targets unreliable, one is tempted to give up – and many shareholders have.
Despite AT&T's substantial underperformance and all-time low relative valuation, active shareholders do not support the current AT&T narrative, and many of the world's largest active managers are noticeably underweight AT&T. These shareholders – whose allocations would represent tens of billions of investment dollars even if just equal-weighted – have decided to deploy that capital elsewhere. In fact, of all publicly traded mega-cap companies in the U.S., AT&T is the second-least-owned by active managers.
Click the following link to view Mutual Fund Weighting of Mega-Cap Stocks in S&P 500: https://activatingatt.com/image9.
This near-total loss of investor confidence has translated directly into share-price underperformance and a depressed valuation. Investors simply will not give any "credit" to management promises and will heavily discount the likelihood of success:
"Attempting to explain why AT&T is trading at an all-time cheap valuation may lead us to the final investor pushback on the AT&T story which is conviction in AT&T's ability to successfully manage these disparate businesses is at an all-time low." – Bank of America, April 2019
"AT&T shares have languished, due, we believe, to concern about the company's video business and the strategy for integrating T's wireless, video, and content assets into a cohesive whole." – Evercore, November 2018
Investor confidence, once lost, is hard to win back. However, such depressed valuations, when found in conjunction with stellar assets, also give rise to unique investment opportunities.
The AT&T Opportunity
As highlighted above, AT&T has nearly been abandoned by shareholders, and understandably so. However, the truth remains that AT&T has irreplaceable assets, enormous earnings power and an ability to win in key markets. Particularly when coupled with a depressed valuation that assumes no changes will be made, we believe AT&T presents as a uniquely attractive business and investment opportunity.
AT&T is a Collection of Leading Franchises
In a world of exponentially increasing connectivity, data usage and content consumption, AT&T – despite the setbacks and issues highlighted above – remains important and valuable. With the right execution and oversight, AT&T's businesses can generate significant value.
Click the following link to view Current AT&T Portfolio: https://activatingatt.com/image10.
AT&T is Deeply Undervalued
Despite this tremendous potential, AT&T stock is historically cheap. As noted above, AT&T's core telecommunications businesses are actually performing well and are well positioned for the future. Unfortunately, the poor results at (the much smaller) DirecTV and general concern about the Company's ability to execute have obfuscated this otherwise-strong positioning.
As a result, AT&T's valuation multiples relative to its own history, relative to the S&P 500 and relative to Verizon are as low as they have been in many years:
Click the following link to view NTM P/E – Last Ten Years: https://activatingatt.com/image11.
The numbers are clear: Today, AT&T trades at just 9.9x P/E, a 20% discount to its historical average of 12.4x. When compared to the broader market, which has enjoyed meaningful multiple expansion in recent periods, AT&T now trades at just over half the multiple of the S&P 500 – by far its biggest discount yet. This discount is particularly startling when considering the impact of Time Warner: AT&T acquired a ~$110 billion business for nearly 20x P/E, yet today its own multiple is roughly half that.
Click the following link to view Dividend Yield – Last Ten Years: https://activatingatt.com/image12.
Similarly, AT&T's ~6% dividend yield presents a uniquely attractive opportunity in today's low rate environment. The spread relative to Verizon has widened meaningfully, and today's more than 4% premium to the 10-year Treasury rate represents its widest spread yet.
Though the last decade has been a challenging period in terms of shareholder value, the next decade need not be. AT&T has highly valuable assets that can drive value creation – #1 or #2 positions in wireless, wireline, pay TV, and content creation and distribution. In our view, the potential of AT&T's leading assets combined with its undemanding valuation makes for a uniquely powerful upside opportunity. What AT&T and shareholders need now is the right plan and a team intent on delivering it.
Focus and Execution: The Activating AT&T Plan
The Activating AT&T Plan (the "Plan") is premised upon immediately instituting strategic focus and operational discipline. By divesting non-core assets; reducing operational inefficiency; instituting capital discipline and aggressively de-levering; and enhancing leadership and oversight, AT&T can improve its business and deliver historic value creation for all stakeholders. The Plan is comprised of four parts:
Click the following link to view the Activating AT&T Plan: https://activatingatt.com/image13.
I. Improved Strategic Focus
The first step in the Plan is a full review of AT&T's portfolio, including an analysis of which businesses AT&T must prioritize today and which businesses are distractions and should not be part of the portfolio. The review should include a full analysis of the Company's myriad distribution and content assets – wireless, wireline, satellite, film, TV, advertising and others – so that AT&T can implement (and articulate) a cogent and focused business strategy.
A key underlying premise of this step is that AT&T must undergo a strategic shift away from acquisition and toward execution. Even aside from the questionable strategic fit of its M&A, AT&T has spent far too much of the past decade in acquisition mode. Acquisitions require a significant allocation of time and resources – both capital and employee time – that AT&T has been unable to spare.
Beyond just the organizational distraction, this constant barrage of M&A leaves investors (and employees) in a state of wondering "what's next," especially given AT&T's history of stacking acquisitions in close succession. Iusacell and Nextel Mexico were both announced in the time between signing and closing the DirecTV acquisition, while the acquisition of AppNexus was announced just weeks after completing the Time Warner deal.
Focused execution now is critical given the numerous time-sensitive initiatives across AT&T – including the ongoing 5G rollout, WarnerMedia direct-to-consumer offering, pay TV stabilization and others – and this sense of urgency is driving our call for AT&T to take action today.
As part of its strategic review, AT&T must also look to divest businesses that are not core to this new strategic focus. The potential value creation to be unlocked through dispositions is beneficial on multiple fronts: AT&T will be able to generate meaningful proceeds today that can be used to both repay debt and invest in its highest-value strategic initiatives. However, the value is far greater than just financial, as this exercise will enable management to focus both attention and resources on its most important business lines.
We do not want to preordain the results of this review, but it is clear that AT&T has numerous valuable-yet-non-core franchises that would be potential candidates for divestment, either as assets sold for cash or spun-off alone or in combination. These include the well-known examples of its home security business, regional sports networks, CME, Sky Mexico, Latin American pay TV business (Vrio), Puerto Rican operations and many, many more. AT&T has taken some early steps in this direction, but more needs to be done.
However, this review should not be limited to "smaller" businesses: Any assets that do not have a clear, strategic rationale for being part of AT&T should be considered for divestment: DirecTV, the Mexican wireless operations, pieces of the wireline footprint, and other assets must all be evaluated as part of this review. Several of these larger assets are no longer complementary with the Company's future strategic direction, and AT&T must determine whether there is a financially and strategically attractive path to divesting them.
There are numerous major portfolio actions that AT&T can take to unlock value, all of which should be thoroughly explored. While we look forward to sharing our initial views with the Board, the critical step is for AT&T to fully and formally embrace this review process today.
II. Significant Operational Improvements
To address operational performance, we believe AT&T should immediately initiate a review of its operations aided by third-party advisors. The review should evaluate all functional areas and business units of AT&T's operations and organizational structure, with a focus on eliminating inefficiency and creating a faster-moving organization.
Efficient Operations Drive Better Management
Making AT&T's operations more efficient would provide benefits that go well beyond higher profit margins. While unsurprising for a former regulated monopoly which many still liken to the federal government, AT&T suffers from a bureaucratic organization. By eliminating duplicative layers, reprioritizing wasteful spend and focusing the organization on the most important tasks, we (and our team of consultants) have found that companies grow faster. They accomplish this by focusing management attention on the areas that matter, re-prioritizing key talent and freeing up capital to invest in growth opportunities. In addition to these benefits, optimizing the cost structure allows companies to increase their competitiveness for new and existing business.
For AT&T, having a cost structure that is competitive with peers' and which enables the maximum amount of capital to be invested in key areas is going to be critical to winning in its markets. There are a number of promising initiatives that will require heavy investment over the coming years. By eliminating wasteful spending and reprioritizing a portion of those dollars towards these high-potential investment priorities, AT&T will ensure that its attention and resources are properly directed and best position itself for future success.
Areas for Improvement
With the help of our consultants and industry executives, we have identified opportunities for improvement across AT&T and all of its component businesses. In total, the Plan calls for a 36% adjusted EBITDA margin in 2022, representing 300bps of EBITDA margin expansion over the next three years.
While we have identified opportunities for savings well in excess of $10 billion, this 300bps target only represents a net cost reduction of $5 billion and was conservatively designed to encourage AT&T to identify savings to invest into growth areas. While we look forward to sharing more details with the Board, some selected opportunities are below:
Among the industry consultants, former employees and industry executives with whom we have spoken, a consistent theme emerges: AT&T is inefficiently run. While we look forward to sharing our primary diligence with the Board, a few data points are easily observable. For example, in addition to losing share to Verizon, AT&T's wireless business is also far less profitable than Verizon's. In fact, the profitability gap has actually widened recently: AT&T's wireless service EBITDA margins have always been lower than Verizon's, but last year the gap in service EBITDA margins increased to ~1,500bps on a comparable basis with historical periods, the largest discrepancy to date and a substantial difference in profitability.
Moreover, Verizon continues to aggressively remove costs from its operations. These efforts are perhaps most noticeable in the changing trends in company-wide employee counts. While revenue per employee was nearly identical at both companies just over a decade ago (~$400k), today Verizon's revenue per employee (~$900k) is nearly 30% higher than AT&T's (~$700k). And Verizon is continuing to streamline, currently executing against a $10 billion cost takeout program and reducing headcount by more than 10% in the last year alone. By comparison, 300bps of margin expansion at AT&T would represent a net cost reduction of just over $5 billion – a number half as large as Verizon's despite AT&T's roughly 50% larger cost base. While some of the gap in AT&T's profitability may be more difficult to address, our conversations and diligence have identified a material amount of cost differential that can be.
Importantly, wireless is not the only business underperforming its profitability potential. EBITDA margins in the Entertainment Group have declined by ~400bps over the past two years on a comparable basis. Such margin degradation would be disappointing in isolation, but it is particularly concerning given that it occurred alongside AT&T's claims to have identified more than $2.5 billion of synergies, or more than 500bps of margin improvement, during the same period. While we recognize the challenging revenue trends in this segment, we have identified a number of areas for further cost rationalization.
Review Should Commence Without Delay and Include a Long-Term Goal
While the Company has periodically taken steps to reduce costs, more can be done and with greater consistency and urgency. Rather than piecemeal improvements over time (or as needed to hit certain quarterly targets), AT&T should undertake a bottom-up review of its cost structure and begin executing against a multi-year improvement plan. Importantly, crafting and then executing against a long-term plan gives all employees something to drive towards, which is a far preferable state of affairs compared to one-off actions that leave employees feeling in a constant state of flux.
As AT&T is currently making critical business and capital allocation decisions, it is our strong view that this review should commence without delay.
III. Formal Capital Allocation Framework
As mentioned above, much of the damage to shareholder and business value at AT&T has occurred due to its capital allocation decisions. A formalized capital allocation framework – in which AT&T makes firm commitments regarding how it will, and how it will not, allocate capital – is an essential part of the Plan. We were encouraged that management recently mentioned exploring share repurchases, which is a good first step. But a formal framework will go much further in conveying a disciplined and underwrite-able approach to the Company's capital.
We recommend four fundamental priorities: 1) focus on current assets and commit not to engage in material M&A, 2) maintain AT&T's highly attractive dividend, 3) increase financial stability through continued debt repayment with a sub-2.0x target, and 4) use ongoing repurchases to enhance shareholder returns.
When combined with the other elements of the Plan, AT&T will be de-levering and reducing its share count at a time of substantial earnings growth, thereby generating significant value for shareholders. Adopting a formal commitment to how AT&T deploys its precious capital is likely the most important step in restoring shareholder credibility and confidence.
IV. Enhanced Leadership and Oversight
While we strongly believe that the Plan outlined above will create substantial value for all stakeholders, success is predicated upon having the right team in place to execute and oversee it.
Aligning Management Skills with AT&T's Challenges
AT&T has suffered from operational and execution issues over the past decade, for which the current le