Is AT&T's Share Dilution A Problem?

| About: AT&T Inc. (T)

Summary

AT&T got downgraded due to $40 billion in share issuance for the acquisition of Time Warner.

This increases the total dividends AT&T will have to pay going forward, unless it cuts its dividend.

That's only one part of the story, though.

AT&T (T) will issue about $40 billion worth of stock to finance the acquisition of Time Warner (TWX), but investors should not worry about that fact too much; the addition of Time Warner's business will make up for the higher share count.

Last week, AT&T's shares dropped significantly, after Bank of America Merrill Lynch analyst David Barden downgraded the company's stock. Among other factors for the downgrade, he cited the fact that AT&T will issue about $40 billion worth of stock, which, according to him, spells trouble for the company's dividend payments.

Let's look at that more closely:

Chart T Market Cap data by YCharts

AT&T has a market capitalization of $223 billion, which infers a total number of 6.15 billion shares outstanding. If the company issues $40 billion worth of stock to finance the merger, this means an additional 1.1 billion shares - the total will rise to 7.25 billion.

This obviously means that AT&T's total dividend payments will increase (assuming the dividend per share remains unchanged):

Chart T Total Dividends Paid (TTM) data by YCharts

With a quarterly payout of $0.49 per share (or $1.96 per year per share), AT&T's dividend payments total $11.9 billion right now - after the issuance of 1.1 billion new shares, the total payout will rise to $14.2 billion. The amount of money AT&T will have to pay to its shareholders thus obviously rises after the merger, but that is only one part of the story:

Chart T Free Cash Flow (TTM) data by YCharts

Right now, AT&T's cash flows would be high enough to finance its dividends even after the issuance of new shares, but the payout ratio would rise to a relatively high level of 84%.

This does not factor in the cash flow contribution of Time Warner, though:

Chart TWX Free Cash Flow (TTM) data by YCharts

Time Warner's free cash flow has risen drastically over the last years, currently standing at $4.9 billion for the last four quarters.

When we adjust that number for $1.1 billion in after-tax costs of the debt AT&T has to take on to pay for the remaining $45 billion of the acquisition ($85 billion in total cost minus $40 billion in share issuance), we see that the net impact of the acquisition (before synergies) to AT&T's free cash flow is $3.8 billion. The combined company thus has an annual free cash flow of about $20.7 billion.

Based on that estimate, AT&T's free cash flow payout ratio will be 68% after the merger has gone through - AT&T's payout ratio will thus actually drop by 2 percentage points, as its trailing free cash flow payout ratio is a little higher, at 70%.

We can thus say that the acquisition of Time Warner does not threaten AT&T's dividend growth story at all. If anything, the dividends will get safer after the acquisition is completed. This does not factor in any synergies and future growth due to AT&T offering a great package after it has taken over Time Warner yet, thus the actual result in a couple of years will likely be even better.

What happens when the acquisition gets blocked? I believe that is rather unlikely, but let's look at what AT&T's share price could look like anyways:

Chart T data by YCharts

When AT&T announced the acquisition plans in October 2016, its share price was slightly higher than it is right now. It thus seems unrealistic that AT&T's share price would drop much if the merger gets blocked - after all, shares were more expensive before any plans for an acquisition got public last year.

Takeaway

AT&T will have to issue 1.1 billion new shares for the acquisition of Time Warner, which increases the company's total dividend payments significantly. Yet, the downgrade by Bank of America Merrill Lynch is not justified, since the cash flows of the combined company do grow as well: The company's cash payout ratio will actually decline slightly, which means that the dividend would be safer after the acquisition. At the same time, the dividend growth outlook would improve.

Dividend investors should thus not worry about the acquisition of Time Warner. They should rather be happy about that smart strategic move by AT&T's management.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in T over the next 72 hours.

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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