AT&T Mega-Merger With Discovery: How Should Shareholders React?

Revealed on Might nineteenth, 2021 by Bob Ciura

Telecom big AT&T Inc. (T) has lengthy been a dependable dividend holding for revenue traders. AT&T has usually provided a excessive dividend yield properly above the market common. As well as, AT&T has elevated its dividend annually for over 30 consecutive years, incomes it a spot on the unique Dividend Aristocrats listing.

The Dividend Aristocrats are a bunch of 65 shares within the S&P 500 Index with 25+ consecutive years of dividend will increase.

You possibly can obtain an entire listing of all 65 Dividend Aristocrats (plus vital monetary metrics like dividend yields and price-to-earnings ratios) by clicking on the hyperlink under:

However AT&T has not elevated its dividend in over a yr, primarily as a result of an elevated debt load because of its acquisition spree over the previous few years.

Now, AT&T is seeking to do away with many main belongings it has acquired in recent times—together with DIRECTV and WarnerMedia—which might have unfavorable implications for its dividend.

This text will focus on AT&T’s latest mega-merger information, and the way AT&T shareholders ought to place themselves shifting ahead.

Transaction Overview

AT&T is a telecommunications big, offering a variety of providers, together with wi-fi, broadband, and tv. The corporate presently operates in three enterprise items: AT&T Communications (offering cell, broadband and video to over 100 million U.S. customers and almost 3 million companies), WarnerMedia (together with Turner, HBO, Warner Bros. and Xandr), and AT&T Latin America serving 11 nations.

AT&T is a mega-cap inventory with a market capitalization above $200 billion.

The corporate made an enormous transfer on Might seventeenth, 2021 when it introduced an settlement to mix WarnerMedia with Discovery, Inc. (DISCA) to create a brand new world leisure firm.

Supply: Investor Presentation

Beneath the phrases of the transaction AT&T will obtain $43 billion in a mixture of money, securities and retention of debt.

As well as, AT&T shareholders obtain inventory representing 71% of the brand new firm, with Discovery shareholders proudly owning 29%. The corporate will mix HBO Max and Discovery+ to compete within the direct-to-consumer enterprise, bringing collectively names like HBO, Warner Bros., Discovery, CNN, HGTV, Meals Community, TNT, TBS and extra.

The brand new firm expects $52 billion in 2023 income and the transaction is predicted to shut in mid-2022.

Conceivably, AT&T’s renewed give attention to its telecommunications companies is an try and return to development. By separating its media companies, AT&T intends to refocus on its core competencies, with out the burden of getting to spend money on wi-fi community infrastructure and media belongings on the identical time.

Nonetheless, there are vital implications for AT&T shareholders, significantly for revenue traders.

Dividend Evaluation

In fact, no dialogue of AT&T could be full with out mentioning the dividend. As a Dividend Aristocrat with over 30 consecutive years of dividend development and a excessive dividend yield of seven%, AT&T’s dividend is a serious cause why traders buy the inventory.

AT&T was having some issue rising its dividend after the Time Warner acquisition. In reality, the corporate had not raised its per-share dividend since December 2019. This has truly positioned AT&T’s standing as a Dividend Aristocrat in jeopardy. The corporate would wish to lift its dividend someday this yr with a purpose to stay a Dividend Aristocrat.

After the merger with Discovery, there’s a excessive chance AT&T will cut back its dividend. Not having its media belongings in tow will lead to a big drop in income and money move. And, since AT&T’s monetary sources had been already stretched with its elevated debt load, this makes it unlikely that AT&T shareholders will obtain the identical dividend payout as earlier than on a per-share foundation.

Following the shut of the transaction, the remaining AT&T enterprise expects low single digit income development, mid-single digit adjusted earnings-per-share development, $24 billion in annual capital expenditures, a net-debt-to-EBITDA ratio of two.6x and a resized dividend (to account for the distribution of WarnerMedia) equaling 40% to 43% of $20+ billion in free money move.

Supply: Investor Presentation

This means ~$8 billion in annual dividends (~$1.15 per share) in comparison with the present $2.08 annual fee.

A revised dividend of $1.15 per share would equal a present dividend yield of 4%. That is prone to be considered as a disappointment for traders accustomed to receiving a excessive yield of ~7% from AT&T ($2.08 in dividends per share).

It’s doable shareholders could obtain a dividend from the brand new firm as soon as the merger is full, though traders haven’t any assure of this. For what it’s value, Discovery doesn’t presently pay a dividend to its personal shareholders. Regardless that AT&T shareholders will personal 71% of the mixed firm, it stays unlikely that dividends, even within the combination, will equal the present $2.08 per-share payout.

With that stated, we have no idea the worth the brand new firm will command when it’s spun-off. It’s doable that AT&T shareholders will be capable to instantly promote the spin-off and reinvest the proceeds into the ‘previous’ AT&T firm and preserve their present yield on money invested.

An instance of how this might work out is under:

1. AT&T presently pays $2.08 in dividends per share and trades for ~$29/share
2. We count on AT&T to pay $1.15 in dividends per share publish spin-off
3. For traders to maintain their revenue equal, they must improve their share rely by roughly 81%
4. Subsequently, if the spin-off share value is 81% or extra of the value of AT&T inventory when the spin-off occurs, and if AT&T shareholders obtain 1 share of ‘New Firm’ for every share of AT&T, then A&T shareholders will be capable to instantly promote shares of ‘New Firm’, reinvest in AT&T shares, and preserve their dividend

We don’t know if this may happen presently, so it’s too early to say with certainty that this can be a true dividend discount for AT&T after accounting for the spin-off. It seems to be a dividend discount, however we are able to’t make certain till remaining share costs are realized.

Causes For Optimism

Whereas revenue traders by no means wish to see certainly one of their inventory holdings minimize its dividend, significantly a Dividend Aristocrat reminiscent of AT&T, there are causes for shareholders to be optimistic. The brand new AT&T goes to be simplified, with a renewed give attention to the core telecommunications companies that made AT&T into the trade big it’s at this time.

This additionally means AT&T will seemingly have an improved monetary place with much less debt. Traders ought to take into account that paying down debt has been a monetary precedence for AT&T up to now a number of years. The mega-merger with Discovery shouldn’t be the one deal AT&T has made; the corporate beforehand introduced a lot of asset gross sales and different strikes, all with the aim of deleveraging.

For instance, on February twenty fifth AT&T introduced it should spin off a separate firm referred to as New DIRECTV that may personal the DirecTV satellite tv for pc TV enterprise, in addition to AT&T TV and U-verse video. AT&T will promote 30% possession to TPG for roughly $8 billion, which can even be used to pay down debt.

Subsequently, whereas AT&T’s dividend discount can be a unfavorable for shareholders within the short-term, it might pave the way in which for a return to dividend development down the street. And, AT&T returning to a give attention to telecommunications might assist the corporate higher compete with its fierce rivals Verizon Communications (VZ) and T-Cell US (TMUS), each of that are investing closely in 5G.

Valuation & Anticipated Returns

Our calculations of anticipated returns embody three key inputs: future earnings-per-share development, dividends, and any change within the valuation a number of (indicated by the P/E ratio). We’re reiterating our expectations of three% annual earnings-per-share development for AT&T, in addition to its $35 per share honest worth which is unchanged from our earlier estimate.

We imagine the spin-off might unlock larger worth than the present firm holds. Subsequently, the latest sell-off in AT&T inventory after the merger announcement is a possible shopping for alternative. With a present share value of ~$29, a good worth estimate of $35 plus the 7% present dividend yield implies a complete anticipated return of greater than 13% per yr. Because of this, AT&T inventory stays a purchase.

Closing Ideas

AT&T’s announcement to spin off its media belongings right into a merger with Discovery is prone to lead to a decreased dividend as soon as the transaction is full. Then again, the assorted transactions AT&T has introduced in latest months pave the way in which for a slimmed down, extra environment friendly firm with an improved development outlook and a more healthy stability sheet.

Whether or not traders ought to proceed to carry the inventory relies on the person investor’s targets. For traders solely centered on present dividend revenue, AT&T’s probably decreased dividend could possibly be cause to promote for some, though the inventory ought to nonetheless yield within the space of 4% primarily based on the present share value. This yield is on par with the dividend yield provided by Verizon. We don’t view AT&T as a promote presently as a result of the dividend discount has not but occurred, and since the corporate presents engaging anticipated whole returns at present costs.

Plus, traders who had been additionally involved by AT&T’s excessive debt ranges and slowing development, could discover cause to carry the inventory as a result of firm’s renewed development potential.