AT&T's Exact Dividend Is Unimportant, Buy The Stock On Sale
- AT&T investors appear to be in full-blown panic mode, looking for any sign to exit an investment that's suffered. We plan to invest more.
- The company has the overhang of asset distributions and split offs. Investors are looking for the company's future path.
- The company's FCF story hasn't changed from a year ago. It's spinning out a higher growth asset with an impressive growth profile.
- We see the new Time Warner + Discovery as a big tech acquisition target for companies looking to get into streaming media.
- AT&T's core business still has $20 billion in annual FCF that can drive a variety of shareholder rewards.
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AT&T (NYSE: NYSE:T) is one of the three largest telecom companies with a market capitalization of just over $160 billion. The company's share price suffered again today, hitting its lowest price since the 2008 collapse on purported news of a market slowdown. As we'll see throughout this article, cash is king, and AT&T has the potential to utilize that for strong long-term returns.
A key aspect of evaluating AT&T is evaluating the upcoming split / spin-off of Time Warner. Discovery shareholders are expected to get one share for each share they currently hold and the net total sum of shares is 2.4 billion shares. Since Discovery is expected to hold 29% of the combined shares, simple math can be done with Discovery's stock price to get a value to assign to AT&T's.
As of today, that value is roughly $40 billion that's being assigned to AT&T shareholders. That makes up roughly 25% of AT&T's market capitalization today (or a value of $5.5 per share). However, there's a flip side to look at it. Each share of AT&T will get roughly 0.3 shares of Time Warner. That means, assuming the valuation lines up, a drop in AT&T stock hurts Discovery.
They can feed each other into a down-cycle as AT&T faces non Time Warner pressure.
The second aspect is we feel the current $55 billion market capitalization with $60 billion in debt is a very low valuation from Time Warner. A fellow contributor's DCF analysis has fair value at roughly a $130 billion market capitalization. Given Netflix is at a market capitalization of more than twice that, we feel there's even more potential.
Another way to look at it is the combined company is expected to have 2023 FCF of $8.5 billion and debt reduced from $60 billion to $45 billion. We feel that a company with $8.5 billion in annual FCF deserves more than $55 billion in market capitalization and $45 billion. The market is currently putting a $5.6 / share valuation on AT&T for the upcoming merger.
AT&T Dividend Future
AT&T investors love that dividend. In our view the company made a bad call with its post spin-off yield decline. However, with the methodology of the spin / split-off still to be the decided the yield is uncertain. For example a split off where 25% of AT&T shares are exchanged for Time Warner could be done, decreasing AT&T's outstanding shares to 5.4 billion.
That would put dividends at 6.3% a share based on AT&T's current stock price, which is still a very respectable dividend. Technically with a spin-off the dividend yield would be the same but the dividends per share would be lower. However, there's an important takeaway worth paying attention to, and that is, in our opinion dividends don't matter cash flow does.
It's led to recent articles such as this one, with arguments that AT&T won't allow high dividend rates. However, we see no reason for AT&T to place that restriction, especially when the company will have $12 billion in additional FCF outside of that dividend. The cash hasn't disappeared and a 40-45% FCF will be comfortable maintainable for the company.
AT&T Fair Valuation
In our view AT&T's fair valuation is based on three factors.
The first is the upcoming Time Warner spin-off. The market is valuing that at roughly $6 / share, however, based on a FCF multiple, we would personally valuable it at closer to $10 / share.
That would leave $13-$17 / share in leftover value. Taking the midpoint of our value and the market's value and we hit a remaining valuation for the company of roughly $100 billion that will carry $100 billion in debt for the company. That remaining value by the market will have $20 billion in annual FCF with a dividend $8 billion.
The takeaway here is two fold. First, the FCF will be growing. Second, even if the company chooses to cut its dividend, the only number we care about is that $20 billion in FCF. The company will be paying ~$4-5 billion in annual interest from its debt, which means even without dividends if it pays down its debt, it can drive higher shareholder rewards.
If we were in charge, we'd like to see the company do ~$6-8 billion in dividends, $3-4 billion in annual debt payback as the lowest priority if FCF drops, and ~$8-10 billion in buybacks as long as the market capitalization remains less than $150 billion. We expect that path will drive substantial shareholder returns.
In our view based on the $20 billion annual FCF a fair market cap is $150-200 billion. Verizon (NYSE: VZ) is trading at an almost $210 billion market capitalization with similar annualized FCF, and without the fiber business, worse growth potential in our view.
AT&T's risk is two fold.
The first is competition for the company. The company is third place in a market where it's competing with Verizon and T-Mobile. It has impressive other investments it's working on but its primary source is its mobile business. As announced today, ARPU is expected to top out, and we expect the company will face strong competition.
The second is the company is sending off an asset that has the potential to be its highest multiple asset. That could result in a re-evaluation of the business and already seems to be happening to some extent. The company is focused on a massive buildout, however, whether that pans out remains to be seen for investors.
We've focused on AT&T several times before, however, with the stock almost in free fall we want to take the chance to highlight some facets of our thesis and put some numbers on it. The company's Time Warner business makes up ~25% of its current market capitalization based on the market, but we think it could comfortably be higher with its growth.
More so, the remaining post spin-off business should have $20 billion in FCF trading with an amount of debt equivalent to its market cap. It's also trading at a 20% FCF yield. However it spends this, even with lower dividends, we expect it to provide substantial shareholder rewards. That's worth paying close attention to.
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