- AT&T is set to spin off WarnerMedia sometime in April.
- The new company will have a large content library, but a lot of leverage.
- AT&T has underperformed the broader market over the past two decades by 400%.
- Is AT&T a buy? The stock is cheap, but management miscues muddy the outlook.
- Looking for a helping hand in the market? Members of Best Of Breed get exclusive ideas and guidance to navigate any climate. Learn More »
AT&T (NYSE:T) is set to spin off WarnerMedia into a new video streaming powerhouse sometime in April, and investors are forgiven if they are wondering what to do with the stock in the meantime. As of recent prices, the stock has greatly underperformed the broader market index over the past two decades. Typically, long periods of underperformance might be a foreshadowing of future outperformance. T’s valuation certainly makes such an outlook possible, but future management miscues may stop the party.
T Stock Price
After a rough period since 2020, T is now trading below where it traded two decades ago.
Dividends help improve overall performance, but the relative underperformance typically suggests future outperformance. Is this true for T stock as well?
What Is The WarnerMedia Spin Off?
The most pressing overhang (or catalyst, depending on your view) is the company’s pending spin off of WarnerMedia. T has previously announced that it would be acquiring Discovery (DISCA) to create a streaming powerhouse, combining HBO with brands like Food Network and 90 Day Fiance.
T expects the new combined company to generate $52 billion in revenue and $14 billion in adjusted EBITDA by 2023, with leverage falling from 5x to 3x debt to EBITDA within 24 months of closing.
AT&T Stock Key Metrics
T closed out the year with solid results across all of its core businesses. It continued to add wireless subscribers, and HBO Max continued to grow even as it lapped pandemic quarters.
On an overall basis, T saw its adjusted EPS grow slightly from $0.75 to $0.78 in the quarter and generated $26.8 billion in free cash flow for the whole year.
Looking forward, T has guided for low single digit revenue growth, EPS of up to $3.15, and free cash flow of $23 billion. The WarnerMedia spinoff will account for the difference.
How Will WarnerMedia Spin Off Impact Investors?
If you’re holding T now, here’s what you need to know. Once Warner Bros Discovery is spun off, you will own 24 shares of WBD (the proposed ticker) for every 100 shares of T owned.
The annual dividend will be slashed to $1.11 per share, representing just over a 4% dividend yield.
T will also receive $43 billion from the new company that it will use to deleverage its balance sheet. Another way to look at it, T aims to push much of its debt load off to the new company to begin anew.
What Is T Stock's Forecast
Looking forward, Wall Street consensus estimates call for very mild earnings growth from the company.
It is worth noting that T’s guidance of $3.13 in EPS is only mildly higher than the $3.05 in EPS it posted in 2017. A big problem has been the company’s inability to materially grow its core mobility business while facing persistent headwinds in its wireline businesses. We can see the 2017 and 2018 EBITDA results below:
Compare this with the lack of mobility growth and the steep overall adjusted EBITDA decline below:
With this context in mind, the conservative consensus estimates appear more understandable.
Is AT&T Stock A Buy, Sell, or Hold?
Is T a buy at the current price? At first glance, the stock looks like a buy. The company has guided for leverage to drop from 3.22x as of the latest quarter to 2.5x by the end of 2023. The company trades at 7.5x forward earnings estimates and has a high free cash flow conversion rate. Intuitively, it is quite appealing to buy into this stock and wait for the company to pay down debt for several years before returning cash to shareholders. At some point, if T can direct all free cash flow to rewarding shareholders, then the stock should re-rate higher to an earnings yield of perhaps 7%, suggesting around 100% upside just from multiple expansion alone.
That is the investment thesis in a nutshell. Unfortunately, this is one of the cases where management execution stands in the way of shareholder performance. I have previously mentioned T’s poor stock performance over the past two decades. The underperformance is more striking when put in comparison with the total return of the broader S&P 500 index (SPY), which has delivered nearly 400% more in returns.
What happened? Sure, the business itself isn’t particularly the sexiest or growthiest. Yet company management delivered many self-inflicted wounds, including its $49 billion acquisition of DirectTV, which it got rid of in 2021 for $7 billion in cash. This latest spinoff of WarnerMedia is sometimes discussed as being game-changing, but a cynical view can see it as being of a similar result as the DirecTV acquisition. In particular, after T made its acquisition of WarnerMedia, the company guided for 2019 to see debt to EBITDA of 2.5x. Leverage stood at 3.22x as of the latest quarter and the company is again guiding for a 2.5x leverage ratio, but this time by 2023. If there was not a history of missed execution, then I would be more believing of the 2023 guidance. Yet, this all feels like a deja vu. T is indeed a cash cow, but management has a track record of prioritizing cash-intensive acquisitions instead of returning that cash to shareholders through share repurchases.
There is also the issue of the WarnerMedia Discovery spinoff. It is possible that this company eventually succeeds, but I am not one to share the notion that such a result is clear at all. The company is expected to have debt to EBITDA of 5x at closing - in comparison, their main competitor Netflix (NFLX) has debt to EBITDA of just under 1.5x. WarnerMedia Discovery will have to invest heavily to compete with NFLX, but my personal take is that it will not be so easy to accomplish that, let alone with such a high leverage ratio at the starting point. Between paying off debt and investing in content, the odds are actually heavily stacked against the company’s success to take market share away from NFLX.
In closing, I acknowledge the low valuation, which arguably could more than compensate for the poor business fundamentals. Yet I am skeptical that management will really stick to the game plan of paying down debt and eventually repurchasing shares, and that has huge implications for future shareholder returns. I am rating the stock “hold” or “avoid” until the capital allocation policies become more clear.
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of NFLX either through stock ownership, options, or other derivatives. 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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