The year-ago quarter

Total revenue improved from the year-ago quarter and surpassed the Zacks Consensus Estimate. Strong earnings from the Wireless segment were driven by subscriber addition, connected device additions and higher smartphone sales. The dampener was Wireline revenue, which was impacted by declining traditional voice access lines.

AT&T added 1.1 million wireless subscribers to reach 98.6 million. The growth was attributable to the rapid adoption of smartphones, strong prepaid subscribers and growth in connected devices.

The wireline front

On the wireline front, U-verse TV and bundled satellite subscribers remained healthy while the quarter on continued high-speed Internet attach rates. However, total consumer connections remained depressed due to a drop in traditional voice access lines, partially offset by higher U-verse TV, broadband and VoIP (Voice over Internet Protocol) connections.

The analysts have turned positive based on AT&T’s strong smartphone portfolio. They expect 2011 to be a strong year with continued revenue growth, margin expansion, and growth in revenues per share and free cash flow. The improvement will be primarily driven by strong iPhone and smartphone sales coupled with growth in tablets and connected devices that are accelerating subscriber gains during reducing churn.

AT&T met its previous target of 12 smartphones and introduced 5 new Google Inc.'s Android smartphones on strong adoption. The new additions bring the total number of smartphones to 19 for the year. This is a huge success for the company in the current competitive environment.

Further, in spite of the loss of exclusivity to its largest rival Verizon Communication this February, AT&T is gaining indiscriminately from strong Apple Inc. iPhone 4 sales. Last week, AT&T saw an astounding demand for the new iPhone 4S, which marks the best order ever received by the company for the iPhone.

Moreover, the company launched its long-awaited 4G Long-Term Evolution wireless networks in the U.S. last month. The company has at first launched its services in five cities namely Atlanta, Chicago, Dallas, Houston and San Antonio and looks to cover roughly 15 markets and 70 million Americans by the end of the year.

The hotel WiFi business

AT&T as well seeks to enter into the hotel WiFi business. Just in case, AT&T’s billion-dollar investment in cloud computing services will open new opportunities for future growth. In addition, the company joined hands with a social gaming company, Zynga, to add more value to wireless subscribers.

Going by the iPhone track record, we expect AT&T to gain more subscribers from the new 4S, and accordingly rake in higher earnings. During iPhones are offering a strong growth momentum, the related high marketing cost is hurting AT&T’s revenues. In addition, the company is currently paying a hefty subsidy of roughly $300 per phone to Apple, which is dilutive to the company’s revenues.

We believe AT&T’s ambitious $39 billion proposed mega-merger with T-Mobile would add more wireless subscribers, improve revenue and profits with enhanced networks. Furthermore, we expect Wireless revenue to continue growing with the new iPhone 4S and strong Android smarthpone sales as then as network upgrades. Wireline revenue would as well improve on enhanced AT&T U-verse services and solid cost management.

However, persistent declines in traditional voice access lines, aggressive pricing plans by rivals and the loss of iPhone exclusivity keep us cautious on the stock. Furthermore, the proposed merger as well faces certain regulatory hurdles.