I imagine the last idea investors want to hear about is AT&T (T) . The company’s stock has been a perennial dog, amid ill-advised acquisitions, broken promises from management and tough competition.
The only redeeming quality of owning T has been the heady dividend yield. Even so, the stock manages to lose annually close to the equivalent of the dividend payout, so holding the stock seems all for naught. Indeed, investors are frustrated with T, but after AT&T’s investor day last Monday, the opportunity appears too compelling at the current price prior to the Discovery (DISCA) deal closing.
First, terms of the deal.
AT&T is set to split off Warner Bros to Discovery shareholders, which is likely to occur in mid-April. The transaction will give T shareholders 0.24 of a share of the new Warner Bros Discovery (with all current Discovery shares getting wrapped in) for each share of T. The value T is getting is extrapolated from the current value of DISCA, 71% of a $62 billion company, so at the current price of around $26 for DISCA, T holders have about $6/share in Warner Bros Discovery value. Subtracting that from T share price of ~$23, the remaining $17 will encompass the new AT&T stock. As part of splitting off Warner Bros, AT&T will transfer over $40 billion in debt to the new Warner Bros Discovery.
Now, for the compelling part.
With T at the equivalent of $17 post-deal, the shares will be among the cheapest in the S&P 500, yet the company provides an indispensable service with a growing business producing strong cash flow. The new AT&T will be a $120 billion market cap company, growing revenues at low single digits, earning this year around $2.30/share and $20 billion in expected cash flow in 2023. The 40% dividend payout ratio will yield over 6%.
The pro forma shares of T have a P/E of 7 and double-digit free cash flow yield — metrics that provide the stock limited downside and plenty of upside as Wall Street gets comfortable with the more focused, less complex and indebted AT&T. Management sees potential for stock buybacks after the capex surge peaks in 2023 and net debt declines to $110 billion.
Owning Discovery may also prove worthwhile; the split will consolidate the media industry and allow the new Discovery Warner Bros more synergistic possibilities. T holders will own about 75% of split off company, and it will undoubtedly encounter a shifting shareholder base once the deal is completed.
Many current T holders will likely jettison the Discovery stub, and the Warner Bros Discovery shares may take time to find their proper valuation, especially with the large debt load. Notably, Warner’s assets, HBO as the crown jewel, have a chance to thrive with a better management than AT&T’s.
AT&T’s wireless business has performed solidly in recent quarters, an industry leader in customer additions. Verizon (VZ) trades with a P/E of 9.5 and 5% dividend yield. Shares of T will likely close the 25% valuation discount to its top competitor after the close of the Warner Bros deal. Even a more reasonable 10% discount to Verizon can prompt a 20% rally in T shares.
Wall Street is taking a wait-and-see stance before the deal closes to decipher how AT&T and Warner Bros Discovery will trade post-deal, possibly missing the opportunity to own DISCA at a reasonable valuation and T at a bargain-basement price. At AT&T’s investor day, management laid out a credible plan of organic growth and cost-cutting that will help support assumptions for solid earnings and free cash flow.
Any appreciation by Wall Street for AT&T’s consistent and growing cash flow will result in a much higher stock price. T is too cheap to ignore, presenting a buying opportunity before the deal closes in April.