When AT&T (NYSE:T) first announced it would spin off its HBO unit with Discovery (NASDAQ:DISCA), shares soared. Almost immediately after that, though, T stock fell. When the company later clarified the details of the stock distribution to shareholders in late January, shares fell once more. Overall, the stock plunged from over $31 to around $24 today.
Why are speculators and income investors having a field day with AT&T right now? There are a couple of things about this deal that readers should keep in mind.
Here’s what you should know about T stock moving forward.
User Growth Should Lift T Stock
In the fourth quarter, AT&T posted revenue of $41 billion. This was down 10% year-over-year (YOY). However, the company also earned 69 cents per share. That’s compared to a $1.95 earnings per share (EPS) loss in the prior year. The Mobility unit was a particularly bright spot in the report, with revenue up 5.1% YOY to $21.1 billion. Communications revenue also rose by 2.4% YOY while Business Wireline revenue fell.
What’s more, the company recorded 1.3 million postpaid net adds in mobility and 4.5 million for the year. The postpaid phone churn of 0.85% was very low. However, with mobility’s operating income margin of 25.3%, AT&T looks like a steady income stock after the HBO-Discovery split.
That’s not all, though. WarnerMedia also added an incredible 13.1 million subscribers in the period. It ended Q4 with 73.8 million subscribers in total. Importantly, it also added 5.3 million domestic subscribers for the full year.
With Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) raising subscription fees, HBO may soon follow. In the report, the domestic HBO subscriber average revenue per user (ARPU) was $11.15. Still, HBO may wait until after the spinoff to raise its rates. It should be able to attract more sign-ups at the lower price. That will help it stay competitive, too.
Opportunity with the Spinoff
Currently, AT&T has a single-digit price-earnings (P/E) ratio, but it may not last much longer. The stock scared income investors after the dividend cut. Shareholders will get $1.11 per share annually in dividends, down from $2.08. This will happen after the company closes the deal.
However, existing shareholders will also get 0.24 shares of the new Warner Bros. Discovery common stock for every share of T stock they own. This means that investors will keep the AT&T stock and get the spinoff WBD stock. That makes this a best-of-both-worlds investment in my view.
AT&T is an income stock now and will be afterward. On the other side, WBD shares — once distributed — will give shareholders a highly valued media asset firm. HBO and Discovery offer a unique content set, which will help subscriptions grow. Plus, WBD stock may even pay a regular dividend.
For now, investors should consider holding T stock and forgetting about it. The three- to five-year value of the two assets will likely rise by at least 30%.
In a five-year discounted cash flow revenue exit model, use a revenue exit multiple to calculate terminal value after five years. Based on the metrics in the table below (the model courtesy of Finbox), the fair value is over $32 per share.
|Discount Rate||8.0% – 7.0%||7.50%|
|Terminal Revenue Multiple||2.6x – 2.9x||2.8x|
|Fair Value||$29.05 – $35.82||$32.37|
Risks Compared to Related Firms
That all said, there could be some risks. For example, the market capitalization of the new Warner Bros. Discovery may fall in value this year. ViacomCBS (NASDAQ:VIAC) is already trending lower despite a P/E in the high single digits as well. Comcast (NASDAQ:CMCSA) shares also peaked at nearly $62 in September 2021. Investors sold the stock every time the entertainment and communication services firm tried to rally.
Roku’s (NASDAQ:ROKU) peak last year at $490.76 has hurt investor confidence for streaming media firms as well. The pandemic could be nearing an end soon, causing a behavior change. The fear? People will spend less time on the couch consuming hours of online content.
Still, according to the Stock Rover chart above, AT&T is trading at below most of its valuation metrics. Most importantly, the company’s P/E ratio is near a low level not seen in years.
AT&T’s core mobility business will not weaken in a post-pandemic world. Conversely, Warner Bros. Discovery may underperform in the next one to two years.
Fair Value and the Bottom Line on AT&T
In addition to the $29 to $35 fair value calculated above, investors should consider analyst ratings when it comes to T stock. Almost half of the Wall Street analysts covering it on Tipranks rate the stock as a buy. The other half thinks the stock is a hold. The average price target for it is currently $29 per share.
T stock is worth more than that beyond one year. As such, income investors seeking a modest growth element should consider the shares now. After all, the uncertainties of the two companies are minimal. They both benefit from strong cash flow and user growth.
In my view, the markets are overthinking the value of AT&T compared to other telecom and communication services firms. As a result, T stock trades at too steep of a discount. As market volatility eases, value investors with one- to five-year time horizons will regain a level head. With that, they will consider accumulating shares at today’s prices.
On the date of publication, Chris Lau did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.