There are two major events on the horizon for AT&T (NYSE:T) shareholders. First, the company will create a new company called Warner Bros. Discovery through a merger between its WarnerMedia subsidiary and Discovery Inc. (NASDAQ:DISCA). It will then spin off 71% of those shares to AT&T shareholders. This will have a major positive effect on T stock.
Second, AT&T’s DirectTV unit has been carved out to a private equity firm. With no media assets associated with the remaining wireless company, AT&T will cut its dividend by about 50%. I talked about this in my last two articles on AT&T. The cut will have a negative effect on T stock.
Fortunately, the dividend cut won’t happen until the merger and spinoff of WarnerMedia, and that could take several more quarters.
Debt Paydown Is the Third Benefit to T Stock Holders
However, there is a third positive event that will help the remnants of AT&T, and by extension its shareholders. Once it receives all the regulatory sign-offs it needs to close the merger, AT&T will receive $43 billion in payments from the new Warner Bros Discovery company. It will also get $7.3 billion from the new DirectTV company (partially sold to TPG Capital).
AT&T plans to use this $50.7 billion to pay down the company’s $167.9 billion in net debt. Their goal is to get down to a 2.5x enterprise value (EV) to EBITDA ratio. This will help the valuation of T stock by reducing its net debt by 30%.
So, theoretically, we have two positive event horizon scenarios and one negative one. The problem is we cannot exactly figure out yet how many Warner Bros. Discovery shares each AT&T shareholder will receive.
But just to make things interesting, I thought I would paint one possible scenario of how all three of these events would work out for shareholders.
Scenario Analysis for T Stock
Keep in mind that this is just one possible scenario. We don’t know the exact spin-off ratio for Warner Bros. Discovery shares (let’s give it the symbol WBD.) But we know that the remaining company’s stock (T) will fall by the dollar value amount of the WBD spin-off. Additionally, the T stock dividend will be cut and this could also make it drop.
On the other hand, the WBD stock will begin paying a dividend as per the original announcement, so that might make up the difference of the T stock drop. The WBD stock shares will also likely rise in value, and could potentially recover a lot of the lost value from the lower T stock price.
For example, let’s assume that for every 100 shares of T stock, shareholders will receive 30 shares of WBD. Let’s assume that T stock falls by 50%, but that WBD ends up with a value equal to that 50% fall. Additionally, let’s assume that WBD stock pays a dividend that is equal to 50% of the dollar value of the T stock dividend. However, T stock might also rise over time, despite the dividend cut, given that it is now more focused and healthier from a financial standpoint.
Therefore, in this situation, shareholders will likely end up with a neutral to slightly higher return, especially if the WBD stock rises more than AT&T falls. But to get this return, they have to hold on to their WBD shares.
However, this might not be the situation at first. That is because many T stock shareholders will immediately dump their WBD shares. Most of these people will likely be worse off in the long run, even though WBD could initially fall from all these selling shareholders.
What to Do With T Stock
You can probably see that the best returns will likely accrue for shareholders that hang on to both their AT&T shares and their Warner Bros. Discovery shares. That is what long-term investing is all about. However, there could be some pain in the short-term, as many shareholders don’t like to deal with change.
Once we have a better idea of what the spin-off ratio will be for AT&T shareholders, we can get a better picture of what will happen. Until then, most defensive investors will likely hang on to their shares and collect their 7.47% dividend yield as long as they can.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.