Due to an acquisition spree, AT&T (NYSE:T) has grown into this massive monolithic company. Rather than achieve economies of scale, T stock experienced diseconomies of scale due to the company’s size and bloated management. That led to stagnation with its assets unable to achieve its growth potential.
Recent re-organization by management has the potential to unlock the value of these trapped assets. This would be very beneficial to investors of T stock as the market could re-rate these assets as stand-alone entities.
If these assets could fetch a higher valuation multiple simply by spinning off, T stock could see significant upside from these price levels.
New Deal to Unlock Value of HBO Max
AT&T management announced a deal last May with the express intention of unlocking the value of its highly prized WarnerMedia division. This deal will merge WarnerMedia with Discovery (NASDAQ:DISCA) to create a standalone entity called Warner Bros. Discovery.
The combined entity will be one of Hollywood’s biggest studios and a global entertainment and media powerhouse.
Under the terms of the agreement, AT&T would receive roughly $43 billion in cash, securities, and debt reduction. This will go a long way in reducing the company’s $169 billion debt burden. The deal would reduce the company’s net leverage from 3.1x adjusted EBITDA to 2.6x adjusted EBITDA.
There is a cumulative effect of reducing AT&T’s debt burden. Interest rate expense would be lower because of the reduction of the debt size as well as the improved credit standing of the company. Both Moody’s and S&P have rated AT&T’s debt only two tiers above junk status. A re-rating from these firms could result in a lower interest rate for the company.
CreditSights estimates that “the company will spend $2 billion to $3 billion less on interest each year after the debt reduction” and that “the deal is a “win-win-win” for AT&T’s credit.”
Warner Bros. Discovery Could Be a Streaming Powerhouse
The combined WarnerMedia and Discovery have the potential to create a streaming powerhouse that could rival both Netflix (NASDAQ:NFLX) and Disney (NYSE:DIS). Warner-owned HBO Max is firing on all cylinders. HBO Max has seen rapid growth in recent quarters ending the second quarter with 47 million U.S. subscribers and 67.5 million globally.
While initially lacking in the original content, HBO Max has made ground this year by releasing its movies on the platform the same day as theaters, including the Oct. 1 release of The Many Saints of Newark. Other titles such as Wonder Woman 1984, Godzilla vs Kong and Mortal Kombat were all made available for free to subscribers.
Despite the gains made by the platform, it is still a distant third place streaming service when compared to Netflix and Disney. These two platforms dominate the streaming market with 208 million and 103 million subscribers worldwide respectively. Adding Discovery+ may just be the boost HBO Max needs in order to catch up.
Discovery adds a lot of great content to HBO Max’s impressive library. Its library includes more than 55,000 episodes of content from Animal Planet, Food Network, HGTV, and TLC. Exclusive content also includes shows from Oprah Winfrey and other popular reality TV shows like Diners, Drive-Ins and Dives and Dirty Jobs.
Holders of T stock would receive new shares representing 71% of this new entity.
Investor Takeaway for T Stock
It isn’t all good news though. As a result of this transaction, T stock has massively reduced its dividend payout. The stock has been sold off as a response as unhappy dividend investors have been dumping their shares. This is good news though for other investors as you can now pick up the company for a cheaper price.
I believe that the investors selling T stock because of the dividend cut are being short-sighted. It was clear that AT&T had not been maximizing the value of its assets. Furthermore, the core business was beginning to suffer which would put the dividend at risk. This is short-term pain for long-term gain.
I commend AT&T management for having the guts to go through with this plan knowing the possible blowback. If they are able to pull this off, T stock may see a lot more upside.
On the date of publication, Joseph Nograles held a long position in T. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.