The Toxic Secrets Of Telecom: Untangling AT&T And Verizon's Lead Cable Controversy

In a hidden corner of our technological history, a potential environmental and health catastrophe is emerging from the shadows. A recent expose by the Wall Street Journal unravels the tangled issue of lead-sheathed cables, once the lifelines of our telecommunication system, now a potential source of toxic contamination. AT&T (NYSE:T) and Verizon (NYSE:VZ) two leading telecommunications giants, find themselves at the heart of the storm, with decades-old decisions casting long shadows over their current operations. Lingering lead cables, predominantly found in mature metropolitan areas, are now under the spotlight for their potential impact on worker safety and environmental health.

In this article, we will analyze the issue, initial responses, and historical precedents, as well as provide a financial and valuation analysis of AT&T and Verizon.

Issue Analysis

Following an investigative journalist piece by the Wall Street Journal, telecommunications giants AT&T and Verizon are facing a significant health and environmental challenge linked to their legacy infrastructure. For decades, these companies and their predecessors used lead-sheathed cables to carry phone service across the United States. Although they have largely been replaced by more modern alternatives, substantial quantities of these cables still exist, especially in older metropolitan areas.

We believe the concern with these legacy cables is twofold:

1. Worker Safety: Studies from the 1970s and 80s revealed high amounts of lead in the blood of employees regularly working with these cables. High lead levels are associated with serious health consequences, including kidney, heart, and reproductive problems.

2. Environmental Impact: Lead is a toxic metal that can leach into the environment. The cables could potentially contaminate the surrounding soil and water. An investigation by the Wall Street Journal found that 80% of sediment samples taken next to underwater cables showed elevated levels of lead.

Per the article, AT&T and Verizon argue that their current practices are based on available scientific literature and legal requirements. They claim that the cables do not pose a public health issue or risk to workers when proper precautions are taken.

Initial Responses

Lawmakers were quick to respond. Senator Edward Markey (D-Mass.) has demanded accountability from the telecom companies, requesting answers to a series of questions regarding the location, monitoring, and remediation plans for these cables. He called for them to guarantee medical treatment and compensation to anyone harmed by lead poisoning caused by the cables.

Representatives Frank Pallone Jr. (D-NJ) and Patrick Ryan (D-NY) shared similar concerns, stressing the imperative to properly scrutinize and address the issue due to the lack of a safe level of lead exposure. Ryan is even considering legislation on remediation of contamination from the cables.

In response, USTelecom, the industry trade group, has stated that there is no evidence that lead-sheathed telecom cables are a leading cause of lead exposure or the cause of a public health issue. The group also set up a "Telecom Cable Facts" website to address concerns, highlighting that the use of lead in telecom cables began to phase out in the 1950s.

While the result is unpredictable, one thing is certain: lawyers, legislators, and the telecommunications industry are preparing for a battle.

Liability Analysis

Considering the precedent of several multi-billion dollar lawsuits in recent history, AT&T and Verizon could potentially face significant financial and legal implications due to the lead exposure issue. Here are some key takeaways and possible liabilities:

Historical cases such as the California Lead Paint Lawsuits (settled for $300M), Roundup (settled for $10B), BP Oil Spill ($21B), PFAS "Forever Chemicals" ($10-$12B settlement by 3M alone), Opioids ($26B settlement from four companies), Asbestos (~$200B), and Tobacco MSA ($206B) reveal that large-scale health and environmental damage lawsuits often lead to substantial financial settlements.

Notably, these settlements have often led to significant restructuring within the companies involved, such as the establishment of "Manville Trusts" under Section 524(g) of the U.S. Bankruptcy Code. This approach offers a method to deal with large numbers of current and future claims related to health damage.

Financial & Valuation Analysis: AT&T

Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.

Over the past three fiscal years, T’s revenue has shrunk at a compound annual growth rate (CAGR) of -12.7%, primarily driven by divestitures and poor organic growth. While the sell-side consensus does forecast a marginal recovery with 1.1% growth this fiscal year, reaching $122.1 billion, and the same the following year, reaching $123.5 billion, it’s clear that T is struggling to grow revenues.

Looking at T's free cash flow (FCF), the consensus estimates predict an FCF margin of 13.5% this fiscal year, down from 16.0% four fiscal years ago. The declining FCF margin and an average capex as a percentage of revenue of 11.4% (indicating very high capital intensity) show that T's business is becoming less efficient with its use of capital.

With a large net debt of $134.7 billion, T is leveraged at 3.1 times its expected current-year EBITDA of $42.8 billion. This high leverage ratio, coupled with a declining FCF and potential off-balance sheet liabilities, as previously discussed, indicates significant financial risk.

T's stock performance reflects these challenges, underperforming the S&P 500 by a whopping 45 percentage points over the past year. Currently trading 23.3% below its 200-day moving average and 36% below its 52-week high, the stock is in a bearish trend. However, its current dividend yield of 7.7% is 620 basis points above the S&P 500, suggesting some income potential for yield-seeking investors.

T's valuation multiples, relative to the S&P 500, demonstrate its current distress. The company is currently trading at an EV/Sales multiple of 1.9, a significant discount of 21.4% compared to the S&P 500. T's EV/EBIT multiple of 9.2 is trading at a 45.8% discount to the S&P 500. The P/E multiple for T stands at 5.6, well below the S&P 500 by 69.6%. The FCF multiple for T is 5.5, which is a hefty 74.0% discount to the S&P 500.

Although T shows a discount in many metrics, the PEG ratio is not one of them. T's forward PEG ratio is presently 3.6, which is 139.2% higher than the S&P 500's PEG ratio of 1.5. This reflects the market's negative outlook on the company's potential for growth.

Financial & Valuation Analysis: Verizon

Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.

Over the past three fiscal years, VZ's revenue grew at a compound annual growth rate of just 1.2%. Sell-side consensus is forecasting revenues to contract by 1.3% this fiscal year to $135.1 billion, before growing by 1.2% the following year to reach $136.8 billion. The company's EBIT margin has also been under pressure, decreasing by 0.7 percentage points over the same period. While the consensus expects a slight recovery in the EBIT margin in the next two fiscal years, the improvement appears marginal.

Looking at free cash flow trends, VZ's FCF margin is forecasted to decline from 14.1% four years ago to 12.5% this fiscal year. This is lower than the average FCF margin of 14.1% achieved over the past four completed fiscal years. VZ's capital intensity, with capex as a percentage of revenue averaging 14.9%, is very high.

With a net debt of $150.1 billion, the company is 3.2 times levered to its expected current-year EBITDA of $47.5 billion. The stock also offers a compelling dividend yield of 7.7%, which is 622 basis points above the S&P 500's yield.

VZ's stock price performance has been disappointing, with a return of -28.0% over the past year, underperforming the S&P 500 by 49 percentage points. The stock is currently trading 15.7% below its 200-day moving average and 37% below its 52-week high. However, short interest remains low at 1.1%, suggesting limited bearish sentiment.

Valuation-wise, VZ appears cheap compared to the broader market. Using consensus estimates for the next fiscal year's results, the stock trades at an EV/Sales multiple of 2.1, an EV/EBIT multiple of 9.3, a P/E multiple of 6.9, and an FCF multiple of 7.2. Relative to the S&P 500, VZ is trading at a discount across all these valuation metrics, ranging from 13.1% for EV/Sales to 66.3% for FCF.

Moreover, the stock's current forward 12-month P/E of 7.3 is historically low compared to its 5-year mean of 11.2 and the 2-standard deviation range of 7.9 to 14.5.

Conclusion

The looming battle surrounding the lead-sheathed cables could cast a chilling effect on the telecom industry, potentially inciting a wave of costly and time-consuming litigation. This situation brings to the fore the imperative need for corporate responsibility in managing legacy issues, especially those with significant health and environmental implications. Should AT&T and Verizon face substantial legal implications from this crisis, it may serve as a harbinger to other industries with similar legacy problems.

The financial analyses of AT&T and Verizon paint a picture of companies already under strain, grappling with revenue growth issues, high leverage ratios, and distressing stock performances. The added pressure of potential lawsuits related to the lead cable issue could further exacerbate these challenges. However, it is important to note that this situation also presents an opportunity for these telecom behemoths to take decisive action, demonstrating their commitment to resolving past mistakes and leading the way in corporate accountability. If AT&T and Verizon successfully navigate these challenges, investors may be well rewarded by picking up these stocks at discounted valuations. The road ahead is fraught with uncertainty and potential opportunity, and as a result, we will watch closely from the sidelines.