We have downgraded our long-term recommendation on AT&T Inc. (T) to Underperform from Neutral as the share price has risen about 29% from last year, nearing its peak level.

The stock is trading near its 52-week high, and investors are suggested to wait for a better entry point. Further, we remain cautious due to competitive pressure as well as a steep decline in its traditional fixed-line phone business.

Last month, the second largest mobile service provider in the U.S. stated its intent to acquire Deutsche Telekom unit, T-Mobile USA, for $39 billion. Following the announcement, AT&T’s share price appreciated rapidly in the last 14–15 days. Thus, the news has already been absorbed into the market and we expect the stock to have little room for further appreciation from the current level.

Although the AT&T/T-Mobile merger would lead to extensive growth in subscribers, revenues as well as profits, the transaction is a time-taking process and might alter the structure of the overall telecommunication industry.

The merger would create a duopoly market for U.S. wireless services. It would further alleviate competition making AT&T and Verizon Communications Inc. (VZ) the two dominant players in the industry that control almost 80% of the U.S. wireless post-paid market.The proposed merger has also raised worries for the telecom industry, especially Sprint Nextel Corp. (S).

We believe the inclusion of T-Mobile operations will position AT&T as the market leader in the U.S. wireless industry and further bolster its mobile broadband services, which are currently booming. The transaction is expected to be earnings accretive in its third year and generate $3 billion in synergies per year.

Additionally, the company is expanding its wireless and wireline businesses, which would in turn fuel profitability going forward. We expect wireless revenue to continue growing with a low churn rate and network upgrades, and wireline revenue to improve on enhanced services in AT&T U-verse and solid cost management.

Though we have reduced our long-term rating, the stock retains the Zacks # 3 Rank (Hold)for the short term (1-3 months) based on AT&T’s efforts to grow revenues, margins, profits and free cash flow in 2011.

 
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