The first stage of the reconfiguration of legacy AT&T (NYSE:T) stock into a new telecom only equity occurred on Aug. 2 when their DirecTV unit and other video businesses were spun off as a separate private company. The separation included approximately 15 million video subscribers.
AT&T will own 70% of the new spin-off while private equity firm TPG Capital will own 30%. Upon closing, AT&T received $7.1 billion in cash as part of the transaction. This will mostly be used to reduced the company’s high debt load.
The company provided updated 2021 guidance prior to the spin-off on a pro-forma basis excluding DirecTV.
ATT&T expects revenue growth in 2% to 3% range and adjusted earnings per share to grow in the low-to middle-single digits. Capital expenditures are expected to be in the $17 billion range. Full year free cash flow is should be around $27 billion.
Although that low level of EPS growth may not seem like much, but when combined with a 7% dividend yield, double digit returns can be achieved over the next 12 months. (However, that dividend will be reduced after the WarnerMedia spin-off, which is expected to occur in mid-2022.)
Owners of T Stock See a Merger
On May 17, AT&T announced plans to merge its WarnerMedia division with Discovery Communications (NASDAQ:DISCA). This comes less than three years after AT&T acquired WarnerMedia (formerly Time Warner) for $85 billion.
T shareholders will own 71% of the new company and DISCA shareholders will receive 29%. The new company will carry $15 billion in debt from Discovery and $43 billion in debt from AT&T. The newly formed company will be a media and content goliath that will generate more than $50 billion in revenues.
HBO continues to be strong growth driver for WarnerMedia, particularly its HBO Max offering launched in May 2020. HBO Max is the streaming version of pioneering cable channel HBO that counted 67 million global subscribers. About 47 million are domestic (U.S.) subscribers. On Aug. 10, the AT&T CFO stated that they continue to experience healthy demand for HBO Max in both domestic and international markets. Year-end guidance was raised to between 70 million to 73 million subscribers on a global basis.
Interestingly, WarnerMedia opted to stop offering HBO as a subscription on Amazon channels. However, this move was already considered into the company’s subscriber guidance for the full year.
As a reminder, T is expected to receive approximately $43 billion from the transaction and a 71% ownership in the new company. The newly merged company is expected to generate $52 billion in revenues and $14 billion in EBITDA by 2023, the first full year after the deal closes. Free cash flow conversion is expected to be very strong at approximately 60%.
The Dividend
T stock will pay a lower its dividend upon closing of the WarnerMedia deal to adjust to the new reality of the company’s prevailing financial profile.
Although today’s dividend yield is excessively high at around 7.6%, I expect that to be reduced to the 3% to 4% range in 2022.
A refocused wireless, fiber and telecom services global telecommunications company will likely be a good thing for AT&T long-term. The company will be operate without the burden and distraction of running complex media companies.
The sum of the WarnerMedia and DirecTV spinoffs, combined with the long-term value of AT&Ts remaining core business, is likely much higher than today’s price.
Morgan Stanley has produced a bull case target of $46, a base case of $32, and a bear case of $26. With T stock trading near the bear-case scenario, this makes it one of the best undervalued investment opportunities in the stock market.
On the date of publication, Tom Kerr did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Tom Kerr has worked in the financial services industry for over 25 years. Mr. Kerr has also been a contributing writer to TheStreet.com, RagingBull.com and InvestorPlace.com. He’s a CFA charterholder and obtained a B.B.A in Finance from Texas Tech University. He also created the 406dad.com kids adventure blog.
