AT&T’s (NYSE:T) long year drags on. Last spring, T stock was trading above $30 per share and investors were reasonably upbeat about its prospects. Then the roof caved in.
In May, AT&T announced that it would be spinning off and merging its media assets with television company Discovery (NASDAQ:DISCA). This was a stunning admission of defeat for AT&T. After all, it had only gotten into the media business a few years ago. However, AT&T’s efforts to scale up HBO and other streaming options failed to succeed, and the company decided to take a new strategic direction.
So what’s it all mean for AT&T going forward? On the other hand, management should be credited for realizing its strategy wasn’t working and making an audible. Still, it’s not like this move is going to fix AT&T’s core structural issues. After all, the company made bold and ultimately failed moves such as buying DirecTV and Time Warner precisely because the telecom business wasn’t growing. Now though, with AT&T shrinking and the dividend slashed, what’s next?
Even Cheaper, On Paper Anyway
AT&T has long looked like a cheap stock, at least on a price-to-earnings basis. However, AT&T stock has dramatically underperformed the market, even as value stocks as a category have started working again. What explains the discrepancy?
For one, AT&T announced that it will be sharply reducing its dividend. This became necessary as AT&T’s debt-fueled spending binge never paid off. At one point, AT&T became the world’s most indebted public corporation given its massive acquisition spree. Yet, these failed to deliver the growth necessary to both pay the debt and the company’s large dividend. So, with the media assets leaving, it was time to cut the dividend.
Many investors, particularly retirees and pensioners, had relied on AT&T’s dividend. With the big cut, a large number of those folks sold T stock and moved to other firms with safer income streams.
Given the further decline in the stock price, isn’t AT&T is a screaming bargain now? Based on the P/E ratio of around 8, it might seem that way. However, the company still has $130 billion of net debt obligations as of this writing. So much of AT&T’s cash flow generation ends up going to the creditors to deal with that. On a more useful enterprise value to free cash flow basis, AT&T is trading at 11 times. That’s hardly expensive, but it’s not a back up the truck bargain either.
Now that AT&T doesn’t have a world class dividend policy anymore, there’s a strong argument for the other telecom firms. A company like Verizon (NYSE:VZ) has shown a stronger track record in terms of both business performance and capital allocation decisions over the years. So if the valuation isn’t a big selling point for AT&T, how about its upcoming spin-off?
New Media Company Already Loses Luster
In theory, Discovery plus Time Warner was supposed to create an A-tier streaming rival. The two together would have the force to stand toe-to-toe with Netflix (NASDAQ:NFLX) and Walt Disney’s (NYSE:DIS) Disney plus offering. That was the idea anyway, and might still be the case.
The problem now is that by the time the deal will be complete, the market has totally shifted. The pandemic-induced streaming tailwinds are long gone. Netflix shares have lost half their value in recent months, and Disney is down dramatically as well.
Even if the Discovery and Time Warner merger ends up being a big winner operationally — which is far from being certain at this point — being a leading streaming player isn’t what it used to be. Given where Netflix and Disney shares are now trading at, don’t count on AT&T’s new media firm garnering a juicy valuation either.
T Stock Verdict
For the past year, the hope was that the media spin-off would drive investor enthusiasm. Instead, the streaming stocks have collapsed, nipping that idea in the bud.
As for the legacy AT&T telecom assets, there is definitely real value there. However, analysts and traders have thought they were cheap since the stock was at $30 and yet the share price keeps dropping. The fact is that this sort of business will be a low valuation one given AT&T’s stagnant growth prospects and massive debtload.
The company should be able to afford its new slimmed-down dividend and support a share price in the current range. As a bond substitute, you could do worse than AT&T at today’s price. However, don’t count on a big comeback anytime soon. There’s little indication that either AT&T’s telecom assets or management team will be capable of generating any such turnaround.
On the date of publication, Ian Bezek did not have (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.
