Should You Jump on the AT&T-DirecTV Merger?

Sometimes the most profitable trend changes in the investment world take place while almost everybody is looking the other way. I’m beginning to think that’s what may be happening right now with the merger of AT&T (T) and DirecTV (DTV).

For more than a decade (really, all the way back to the collapse of the technology-media-telecom bubble in 2000), telecoms  like T and DTV have been market wallflowers. Most have paid decent dividends, but price gains have been singularly lacking, including for T stock and DTV stock.

ATT stockFor good reasons, too. The old-fashioned wireline business has been shrinking inexorably. While broadband Internet and TV have provided new sources of revenue, the cable companies are fighting the telcos for every scrap of this business. Price cutting is pinching the telcos’ last fat profit center — wireless.

And yet, we’ve had two pieces of news in the past week suggesting that their fortunes may be turning for the better.

First, and most dramatic, AT&T has launched a $48.5 billion takeover bid for satellite TV provider DirecTV. Most of the Wall Street commentary around this deal has centered on the benefits to AT&T of having a nationwide video footprint to go with T’s well-established position in cellular (essentially, the company enjoys a duopoly with Verizon (VZ)).

I agree that the merger will strengthen AT&T’s hand from a marketing standpoint. However, I’m even more impressed with the financial engineering that went into the transaction.

In essence, AT&T is taking advantage of today’s low borrowing costs to buy a block of assets that will generate cash flow far in excess of 1.) future capital spending at DirecTV and 2.) the interest expense of the deal. Result: AT&T will have more cash left over for dividends and buybacks of T stock.

Readers who have been with me awhile know that I’ve expressed concern that T’s dividend isn’t as well covered out of free cash flow as Verizon’s is. This transaction takes a large step toward fixing that problem. By 2016, AT&T’s free cash flow should outweigh the dividend by a comfortable 1.8X.

Not Picking Up the Call for T Stock

Even though I applaud the DirecTV deal (and yes, I do own AT&T in personal accounts), I must admit that Verizon remains my favorite domestic telco. I’ve explained the reasons before: dominant market share in wireless; enormous free cash flow covering the dividend an estimated 2.7 times this year.

But I’ve got another reason now, which you may find more persuasive than all my previous arguments. Last Friday, Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A) disclosed that it had built an 11-million-share stake in VZ as of March 31. The shares are currently valued at around $535 million.

Most likely, it was one of Buffett’s lieutenants, Todd Combs or Ted Weschler, rather than the master himself, who decided to purchase the stock. Nonetheless, we know that both of these guys are excellent stock pickers — good enough to get hired by Buffett to run multi-billion-dollar chunks of Berkshire’s portfolio.

To me, that’s all the stamp of approval I need to take a long look at Verizon stock.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won nine Best Financial Advisory awards from the Specialized Information Publishers Foundation.

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