Ahead of AT&T's (T) third quarter earnings report I decided that I would either sell or hold Northlake's shares based on what was reported and what I heard on the conference call. Northlake clients have owned AT&T for almost a year and the stock prices is actually down a bit offset by the hefty quarterly dividend.

I have decided to continue holding the shares following a pretty solid earnings report. AT&T is not growing. Revenues fell by 1.6% and EBITDA fell by 2.8%. However, both figures, along with the adjusted EPS of 53 cents matched or exceeded analyst estimates. AT&T is facing a challenging economic environment that is pressuring their business markets while consumer landlines continue to melt away. The company is also taking a non-cash hit to EPS from pension accounting as a resulting of 2008's stock market collapse.

However, hidden beneath these negative trends is a pretty positive story. Wireless revenue grew 10% and margins surprised to the upside. iPhone activations were robust but so were net adds away from iPhones. Churn was better than expected, a mjor positive for profitability. Margins should have been pressured by the heavy subsidies enabling AT&T to charge $199 for an iPhone for which they pay $5999 to Apple. Good cost controls and a growing base of monthly iPhone users where the subsidy has been absorbed is driving margins. These trends should continue in the future enabling wireless growth to accelerate in 2010, especially at the profit level. Also contributing to the good wireless results was better than expected ARPU. Despite all the worries about wireless pricing, especially on low end plans, smartphones and their data plans continue to attract plenty of less price sensitive subscribers.

Trends is wireline were similar to [prior quarters but cost controls also appeared allowing margins to beat expectations. Data driven business customers remain a growth engine, offset by the continuing and inevitable decline of consumer landlines and pressure on traditional business customer revenues.

Subscriber growth for U-Verse TV and broadband plans continues to be steady although the numbers this quarter were very slightly below analyst estimates.

The investment case for AT&T is that the growth businesses are almost large enough to offset the businesses in a permanent state of decline. The lines should cross soon at just about the same time that cyclical pressures ease. I think 2010 estimates have upside especially when including a likely reversal of non-cash pension charges. Cash flow is well ahead of expectations and well controlled capital spending. Fee cash flow is $14 billion this year versus $8 billion at the same point a year ago. AT&T has been paying debt and building up reserves to pay for already agreed to acquisitions. In 2010, prospects for share repurchases should improve considerably.

The big risk to the stock remains the iPhone exclusivity and the related issue of a strained wireless network. Loss of exclusivity seems likely and the risk of defections to Verizon are high. Alternatively, a negative surprise in capital spending is possible if network enhancements are accelerated.

I see these risk as real but the stock has lagged creating a very cheap valuation at a time when estimates may have upside and stock repurchases may re-emerge. A catch-up move in the shares to the low $30s seems likely if the market cooperates. And if the market falls, the company's solid financial performance, balance sheet strength, and the very healthy 6.3% current yield would make AT&T a good place to hide.