AT&T-Discovery Merger & Spinoff | How Should Shareholders React?

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AT&T-Discovery Merger & Spinoff | How Should Shareholders React?

Updated on August 19th, 2022 by Nate Parsh

Telecom giant AT&T Inc. (T) had long been a reliable dividend holding for income investors. AT&T has typically offered a high dividend yield well above the market average. And prior to its spinoff announcement and recent dividend reduction, AT&T was a Dividend Aristocrat thanks to its 30+ years of rising dividends.

The Dividend Aristocrats are a group of 65 stocks in the S&P 500 Index with 25+ consecutive years of dividend increases.

You can download a complete list of all 65 Dividend Aristocrats (plus important financial metrics like dividend yields and price-to-earnings ratios) by clicking on the link below:


Now, AT&T has largely completed the process of getting rid of many major assets it has acquired in recent years—including DIRECTV and WarnerMedia. These moves resulted in the company reducing its dividend from $2.08/share to $1.11/share.

Note: The company’s May 2022 dividend was — according to AT&T — at the lower $1.11/year ($0.2775 quarterly) rate.

This article will discuss AT&T’s mega-merger, and how AT&T shareholders should position themselves moving forward.

Transaction Overview

AT&T is a telecommunications giant, providing a wide range of services, including wireless, broadband, and television. The company previously operated three business units:

The company made a huge move on May 17th, 2021 when it announced an agreement to combine WarnerMedia with Discovery, Inc. (DISCA) to create a new global entertainment company.

The transaction officially closed on April 8th, 2022. The new company is called Warner Bros. Discovery, Inc., which now trades on the Nasdaq under the new ticker symbol WBD.

Related: Communication Services Stocks List | The 5 Best Now

Source: Investor Presentation

Under the terms of the transaction AT&T received $40.4 billion in cash and WarnerMedia’s retention of certain debt. Additionally, shareholders of AT&T received 0.241917 shares of WBD for each share of AT&T common stock they held at close. As a result, AT&T shareholders received 1.7 billion shares of WBD, representing 71% of WBD shares on a fully diluted basis, with Discovery shareholders owning the remaining 29%.

The company will combine HBO Max and Discovery+ to compete in the direct-to-consumer business, bringing together names like HBO, Warner Bros., Discovery, CNN, HGTV, Food Network, TNT, TBS and more.

Note: The record date for AT&T shares to receive the new spinoff company shares was close of business on April 5th, 2022, according to a press release from AT&T.

The new company expects $52 billion in 2023 revenue according to a recent company presentation. It also expects at least $43.5 billion in adjusted EBITDA, and adjusted EPS of $2.50 to $2.60 for 2023.

Conceivably, AT&T’s renewed focus on its telecommunications businesses is an attempt to return to growth. By separating its media businesses, AT&T intends to refocus on its core competencies, without the burden of having to invest in wireless network infrastructure and media assets at the same time.

Nevertheless, there are significant implications for AT&T shareholders, particularly for income investors.

Dividend Analysis

Of course, no discussion of AT&T would be complete without mentioning the dividend.

AT&T was having some difficulty growing its dividend after the Time Warner acquisition. In fact, the company had not raised its per-share dividend since December 2019.

AT&T announced on February 1st, 2022 that it will reduce its dividend from $2.08/share to $1.11/share in conjunction with the spinoff. Not having its media assets in tow will result in a significant drop in revenue and cash flow.

A revised dividend of $1.11/share equals a current dividend yield of 6.0%, based on the August 18th closing price of $18.43 per share. This is likely to be viewed as a disappointment for investors accustomed to receiving a higher dividend from AT&T, based on its previous $2.08 in dividends per share.

It is possible – though unlikely – that shareholders may receive a dividend from WBD at some point in the future. For what it’s worth, the former Discovery did not pay a dividend to its own shareholders. We expect WBD to not pay a dividend, at least initially.

AT&T shareholders own 71% of the combined company. WBD ended its first trading day with a share price of $26.85.

AT&T received $40.4 billion, and with AT&T shareholders receiving 0.241917 shares of WBD (1.7 billion shares in total), this comes to more than $86 billion for AT&T shareholders, or a value of ~$6.50 per AT&T share.

AT&T shareholders could immediately sell the spin-off and reinvest the proceeds into the ‘old’ AT&T company to boost their dividend yield. If AT&T investors were to sell WBD shares and reinvest the estimated $6.50 into AT&T, this would result in a 33% increase in the number of T shares owned. Looked at through the lens of dividend income:

AT&T is clearly using the spinoff as an ‘opportunity’ to reduce its dividend obligation to shareholders going forward. This is being done in order to have more funds to invest in future growth prospects.

Related: Learn more about spin-offs at Stock Spin-Off Investing.

Reasons For Optimism

While income investors never want to see one of their stock holdings cut its dividend, particularly a former Dividend Aristocrat such as AT&T, there are reasons for shareholders to be optimistic. The new AT&T is going to be simplified, with a renewed focus on the core telecommunications businesses that made AT&T into the industry giant it is today.

This also means AT&T will have an improved financial position with less debt. Investors should keep in mind that paying down debt has been a financial priority for AT&T in the past several years. The mega-merger with Discovery is not the only deal AT&T has made; the company previously announced a number of asset sales and other moves, all with the goal of deleveraging.

While AT&T’s dividend reduction will be a negative for shareholders in the short-term, it could pave the way for a return to dividend growth down the road by further reducing debt and focusing the company on its core competencies.

And, AT&T returning to a focus on telecommunications could help the company better compete with its fierce rivals Verizon Communications (VZ) and T-Mobile US (TMUS), both of which are investing heavily in 5G.

AT&T management updated shareholders on the prospects of the company post spin-off. AT&T expects the following for fiscal 2022:

The company’s expectations for fiscal 2023 are shown below as well:

That said, AT&T provided a further update on the second quarter earnings conference call, where management lowered its free cash flow estimates to ~$14 billion for 2022, but kept most other targets where they were.

With these key numbers, valuation and expected total return estimates can be more accurately calculated.

Valuation & Expected Returns

Our calculations of expected returns include three key inputs: future earnings-per-share growth, dividends, and any change in the valuation multiple (indicated by the P/E ratio).

AT&T is forecasting 4.5% earnings-per-share growth from fiscal 2022 to fiscal 2023. Over the next 5 years, we believe a modest 2% annual earnings-per-share growth expectation for AT&T is both prudent and conservative. This growth estimate may well prove to be too low; there’s certainly room for an upward surprise.

With a current share price of $18.43, and expected EPS in fiscal 2022 of $2.44 at the midpoint of guidance, this implies a forward price-to-earnings ratio of just 7.6.

This appears to be far too low for the company. We believe a price-to-earnings ratio of 10 is a reasonable semblance of fair value. This implies ~32% upside from current prices.  If the valuation multiple were to drift upwards over the next 5 years from 7.6 to 10, this would generate returns of ~5.8% annually.

With a 6.0% dividend yield using the new dividend, 2% expected growth returns, and a mid-single-digit contribution from multiple expansion, we expect total returns of 12.2% annually from AT&T over the next 5 years.

Final Thoughts

AT&T’s announcement to spin off its media assets into a merger with Discovery resulted in a reduced dividend. On the other hand, the various transactions AT&T has announced in recent months pave the way for a slimmed down, more efficient company with an improved growth outlook and a healthier balance sheet.

Whether investors should continue to hold the stock depends on the individual investor’s goals. For investors solely focused on current dividend income, AT&T’s potentially reduced dividend could be reason to sell for some, although the stock still yields in the area of 6.0% based on the current share price.

This yield is on par with the dividend yield offered by Verizon (which is currently at 5.8%). We do not view AT&T as a sell because the dividend reduction is occurring in conjunction with a large corporate change due to the spinoff, and because the company offers attractive expected total returns at current prices.

Plus, investors who were also concerned by AT&T’s high debt levels and slowing growth, may find reason to hold the stock due to the company’s renewed growth potential and deleveraging.

If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:

The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:

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