First-rate communications giant AT&T (NYSE :T) has traded much like a utility share in recent years, and investors have approached the T share as such. He has long been a reliable stock as a dividend aristocrat.
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In search of new growth opportunities, AT&T took a huge step forward in entertainment three years ago with its transformational acquisition of Time Warner. The Time Warner acquisition was meant to provide AT&T with a new growth path with sought-after entertainment properties such as HBO.
The takeover did not translate into the prescribed amount of growth AT&T had hoped for, while imposing a mountain of debt on AT&T.
Today AT&T Merges Its WarnerMedia Business With Listed Companies Discovery (NASDAQ :DISC, NASDAQ :DISCB). The merger will create a streaming powerhouse to support Netflix (NASDAQ :NFLX), Disney (NYSE :DIS), Amazon (NASDAQ :AMZN), Comcast (NASDAQ :CMCSA) and others in the ongoing streaming wars.
For this reason, we reiterate our view that AT&T stock is a buy.
Merger overview
The merger between WarnerMedia and Discovery was announced on May 17, with the combination to be structured as a Reverse Morris Trust transaction. Essentially, a Reverse Morris Trust is simply a way for a parent company to divest assets and then combine them with an entity interested in acquiring those assets. In this case, the parent company is AT&T, with the assets to be divested being WarnerMedia and the acquiring company represented by Discovery.
It’s important to note that the Reverse Morris Trust allows this to happen tax-free, which is probably why AT&T has chosen this route in combination with Discovery.
Under the terms set out, AT&T will receive $ 43 billion from the merger in a combination of cash and cash equivalents, and debt retention. In addition, AT&T shareholders will receive 71% of the outstanding shares of the new company, with Discovery shareholders retaining the remaining 29%.
The mega-merger will combine powers in the streaming industry including HBO and its related properties, Discovery +, CNN, HGTV, Food Network and other leading non-fiction programs.
The transaction is complex and will take time, with a closing date slated for the middle of next year. Following the merger, the company expects the new entity to generate annual revenue of more than $ 50 billion.
For AT&T, the combination means relinquishing control over WarnerMedia and the growth potential it has provided. However, AT&T still expects single-digit revenue growth and single-digit adjusted earnings per share growth after the transaction.
The merger with Discovery has the aforementioned benefits for AT&T, including a significant reduction in debt. The TimeWarner acquisition cost AT&T nearly $ 80 billion when all cash and stock considerations were met, and AT&T emerged from the merger with long-term debt of $ 180 billion.
AT&T believes it will come out of this process with a net debt to EBITDA ratio of 2.6x, which is well below its previous levels which were almost unsustainable.
In addition, AT&T will resize its dividend to take into account the distribution of WarnerMedia, which it estimates represents about 40% of annual free cash flow. This involves a projected dividend payment of $ 1.15 per share, give or take, compared to the current $ 2.08 per share.
Growth catalysts
The merger has significant benefits for the new entity as it combines very valuable streaming properties under one roof. However, for AT&T, we still believe the company has growth opportunities in the remaining businesses.
The merger will allow T stock to focus on its core connectivity and telecommunications businesses, and with much less debt. AT&T will have the ability to step up investments in its growth areas, namely mobile connectivity and fixed broadband services, without the distraction of trying to be a world-class entertainment company at the same time. AT&T has focused heavily in recent years on growing its entertainment business, but will no longer be faced with such a choice and will instead be able to invest in its most important growth initiatives such as 5G.
In addition, AT & T’s capital structure will be significantly improved as a result of the transaction, as it will receive $ 43 billion in cash and cash equivalents with which it can reduce its leverage. This will not only save the company money on debt service charges, but will position AT&T well among its 5G competitors, including Verizon (NYSE :VZ) and T-Mobile (NASDAQ:TMUS).
Billions of dollars of investment are needed to remain competitive in this environment, and AT&T we believe will be in a better position to make those investments post-merger.
T-action evaluation
After the merger, and even before, we still find AT&T to be valued attractively. This year, we expect the company to produce $ 3.20 of BPA. The results for next year will undoubtedly be messy given the transaction to take place and the associated charges. But in the long run, we expect AT&T to be able to gradually repay its debt, pay its dividend to shareholders and possibly buy back shares.
We think the Discovery transaction is sort of an admission that the foray into entertainment hasn’t worked, and that AT&T is more interested in becoming a pure-play telecommunications company again.
The shares are trading for just 9.2 times this year’s earnings estimate of $ 3.20 per share, which is well below our fair value estimate of 11 times earnings. We believe that an AT&T that is purely telecom-focused, and with tens of billions of dollars in debt reduced, is still attractive enough, and shareholders also enjoy the advantage of owning a majority of the new entity.
In light of these elements, we reiterate our buy note on AT&T following the announcement of the merger.
Final thoughts
The T stock is today in a period of significant transformation. The WarnerMedia merger did not go as planned, but we believe that resolving it through the Reverse Morris Trust transaction with Discovery is attractive. AT&T buyers today get a low-cost telecommunications giant with a big dividend and 71% ownership of the new streaming-focused entity by the middle of next year.
With these characteristics, we reiterate our buy note on AT&T.
As of the publication date, Bob Ciura does not have (directly or indirectly) any position in any of the stocks mentioned in this article. The opinions expressed in this article are those of the author, subject to the publication guidelines of InvestorPlace.com.
Bob Ciura has been with Sure Dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a BA in Finance from DePaul University and an MBA with a concentration in Investments from the University of Notre Dame.
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