AT&T Yields 4.7% and Trades At 8 Times Earnings. Is the SpaceX Threat Really Worth That Discount?

AT&T (NYSE: T) appears to face a significant threat from Space Exploration Technologies (NASDAQ: SPCX). COO Gwynne Shotwell announced that SpaceX's connectivity segment, Starlink, will compete with AT&T, Verizon, and T-Mobile as a full-fledged wireless carrier.

Admittedly, such a move appears bleak for AT&T shareholders, since Starlink can cover the entire planet if the law allows, whereas AT&T can cover only the populated parts of the U.S. However, AT&T's 4.7% dividend yield stands out compared to SpaceX, which offers no dividend.

Moreover, AT&T trades at a massive valuation discount to SpaceX, and even with a recent pullback, the competitive threat from SpaceX probably does not justify a discounted valuation for AT&T stock for two reasons.

1. The extent of SpaceX's competitive advantage is uncertain

At first glance, competition from SpaceX appears to put AT&T at a competitive disadvantage. Starlink plans to build a terrestrial coverage network, claiming it will use low-cost ground small cells and femtocells to improve signal where coverage is weak. It believes it offers a lower-cost approach to coverage than the massive networks of existing carriers.

Still, AT&T investors should remember that satellite internet has not threatened its own internet business. Also, Starlink's internet service comes with critical limitations. It needs a line of sight to a satellite, and adverse weather, network congestion, and other factors can negatively affect its service. That is why it needs its own terrestrial network to compete.

Nonetheless, this also raises challenges, suggesting Starlink's service may not add significant value. For one, Starlink has a partnership with T-Mobile in which satellite-to-cell service can take over when the terrestrial network is unavailable. T-Mobile CEO Srini Gopalan said that this type of service accounts for only 0.0003% of its network usage, even during the busiest times of the summer.

Another issue is capital expenditures (capex). Even if Starlink can deliver wireless service at a lower cost, the capex costs could still be considerable. The connectivity segment of SpaceX (Starlink) spent just over $4.9 billion on capex over the trailing 12 months. Connectivity accounted for nearly 12% of SpaceX's capex over that period. That will have to increase, which could affect other parts of SpaceX.

2. An unclear investor benefit

The main reasons to invest in SpaceX's stock, aside from Elon Musk's reputation as an innovator, are a near-monopoly on space launches and the prospect of AI data centers in space. The massive growth of Starlink also contributes to its success, but its satellite-based internet remains a niche market.

Furthermore, investing in SpaceX is considerably riskier than owning AT&T stock. SpaceX does not have a P/E ratio, reflecting ongoing losses. That's one less tool in the standard value investor toolbelt. Buying SpaceX stock today means one pays 85 times sales for a money-losing enterprise that does not pay dividends.

Also, AT&T derives nearly all of its revenue from serving as a wireless carrier and a wireless and fiber-based internet service provider. That makes the company much simpler to understand than SpaceX from an investor standpoint.

Additionally, it produced over $16 billion in free cash flow over the trailing 12 months. Around $8 billion of that free cash flow funds a $1.11-per-share annual dividend, which offers the aforementioned yield of 4.7%, well above the S&P 500's (SNPINDEX: ^GSPC) average yield of 1.2%. Also, it sells at a P/E ratio of just 8, and the P/S ratio of 1.3 is a tiny fraction of SpaceX's sales multiple.

To be sure, AT&T still has its challenges. The company's stock is inexpensive because it has run up massive debt. It has spent heavily on capex and lost tens of billions of dollars in failed satellite TV and media content ventures years ago, leaving it with a strained balance sheet that may concern its investors. Still, its profitability should reassure risk-averse investors, especially when compared with SpaceX.

Choose AT&T stock

Investors should probably stay with AT&T despite SpaceX's plan to become a wireless carrier.

Indeed, Musk has built a reputation for technological transformation, and investors should not forget SpaceX stock. Nonetheless, investors should remember that Starlink has not threatened AT&T's internet service business. Moreover, the massive costs of entering a competitive industry like wireless services offer no obvious benefit to investors.

In contrast, AT&T's stable dividend and low valuation probably make it a less risky investment choice than SpaceX stock. Hence, if you're choosing between these stocks, the safer move is to buy AT&T and collect its generous dividend.

Will Healy has no position in any of the stocks mentioned. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.