Last week, AT&T (NYSE:T) reported Q4 results and provided general guidance for 2017. The key news points were the integration of the DirecTV business and the impact on the thoughts surrounding the Time Warner (NYSE:TWX) merger.
Unlike Verizon Communications (NYSE:VZ), AT&T traded at the highs until the 2.5% decline today. The $41 price actually provides upside for Time Warner shareholders making one wonder if that isn't the best way to play AT&T.
Time Warner Deal
Back in October, Time Warner agreed to a buyout by AT&T of $107.50 per share for a listed value of $85 billion. My initial view of the deal is here.
The deal included the following terms:
- $53.75 per share in cash.
- $53.75 per share in AT&T stock subject to a collar of 1.437 shares if the stock dips below $37.411 and 1.3 shares if the stock price is above $41.349 at closing.
At the time, AT&T traded near the low collar suggesting some downside risk to the value. Now, the stock is near the high-end collar providing upside value to Time Warner shareholders and downside protection.
If the merger were to close today, Time Warner shareholders would obtain the full value that includes $53.75 in AT&T shares plus the cash for a total value of $107.50. AT&T trades near the top collar providing upside potential if the stock breaks out above strong resistance around $42. In that scenario, Time Warner shareholders capture about 50% of the upside. The downside is protected by the roughly $3.50 cushion on AT&T stock.
Outside of a major collapse by AT&T or a blocked merger, a Time Warner shareholder is set to cash in for $107.50 or more. The stock currently trades at $95.90 providing over 12% upside at the closing plus additional gains if AT&T trades higher.
The long-term question is whether the merger creates value. The company projects $1 billion in synergies and the ability to offer content for their bundled services.
Going back to DirecTV, a lot of those promises aren't coming to fruition. The wireless giant promised the ability to sell bundled services that include wireless, pay TV and broadband while reducing costs such as with U-verse.
The failure of the plan is best highlighted in the net video subscriber totals. Over the last five quarters, AT&T has seen video subscriber losses in every quarter. One of the biggest synergy promises was to save on content costs from the U-verse subscribers, but all the company has done is shift advertising toward moving those customers to DirecTV.
Source: AT&T Q416 investor briefing
The wireless additions have been similarly dismal. Over the last year, the total wireless subs are up to 134.9 million from 128.6 million. The majority of the additions come from connected devices with only 0.7 million from the crucial postpaid subs.
Combine these lackluster subscriber numbers from the key wireless and video segments and one has to question if the merger thesis is a bust. As well, one of the biggest hits on the Verizon earnings report was from the restructuring of the content group.
The key investor takeaway is that the promises of the DirecTV merger aren't coming to fruition. All signs point to AT&T buying pay-TV at the top and the potential exists for a similar move with buying video content at a premium price.
Unless one thinks the merger gets blocked, the best way to play the deal is via Time Warner. The stock offers more upside than holding AT&T directly, solid downside protection, and a position in the wireless giant long term.
As for AT&T, the cost savings help secure the 4.7% dividend long term, but the stock is unlikely to rally as the company focuses on completing the merger.
Disclosure: I am/we are long TWX.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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