Is AT&T Stock A Buy Or Sell Before WarnerMedia Spin Off? Not Too Late

Summary

• 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 »

jetcityimage/iStock Editorial via Getty Images

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.

YCharts

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.

WarnerMedia + Discovery Presentation

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.

WarnerMedia + Discovery Presentation

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.

AT&T 2021 Q4 Presentation

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.

AT&T 2021 Q4 Presentation

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.

AT&T 2021 Q4 Presentation

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.

AT&T Dividend Announcement

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.

Seeking Alpha

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:

AT&T 2018 Q4 HIghlights

Compare this with the lack of mobility growth and the steep overall adjusted EBITDA decline below:

AT&T 2021 Q4 Highlights

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.

YCharts

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.

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.

I am long all holdings of the Best of Breed Portfolio

Comments

[value1m]

$VEON bottom T of East EU

[Senior Vagabond]

I own 2000 shares of T bought in 2020 @ sub $30. I have always despised the company's management and terrible execution but gave them a try with some idle cash for the high dividend and a hopeful stable or slight increase in stock price. Obviously neither worked out. I just want to get back to even. If I sell the approx 480 shares of the WBD spinoff won't that be free cash or do you think the share price of T will fall to an equal or greater level after the closing to offset any possible gain with WBD? Excuse me for my ignorance but this whole thing I have found very confusing.

[SD_Dude]

@Senior Vagabond Sub $30 price for $T is not bad for a long term investor. Many analysts have increased their target for $T after the March 11 investor meeting. Yes, $T stock will go down on the day the spin off is complete but you should look at what $T and WMD can do 6 months or longer after this spin-off. If this time frame is not good for you then $T stock is not for you. Remember, $T should have over 6% after spin off.

[pyrotechnic67]

@Senior Vagabond I've posted this elsewhere - I've been critical of T (and T holders) for a long time. But I think mgmt is making the right moves now and I think they will follow thru. T can now concentrate on what they do best (5G), with a div that's comparable to their rivals, and WM will be owned by a company that knows what to do with them. I recently switched my monthly Roth deduction purchase all T, and before the end of March I'll be sending in enuff to ensure that the max contribution allowed for the year purchases T. I think they have a good future, plus the new company will be good as well. Like you, I have no idea where T or WBD will land, price wise. I just think when the dust settles and WS makes some decisions, both will be a good hold.

[Rick Both]

@Senior Vagabond looks like you are suffering from an acute case of evenitus! there is no vaccine for it and wearing a mask will not help! (ps joking- I'm underwater in T myself)

[value1m]

Veon .35ish might bottom mobile phones East europe and asia service.
I beleive will recover to 2 plus after this war.

[Rose_Colored_Glasses]

Oddly there’s never a good time to buy or sell T.

[JEFFREYJR]

@Rose_Colored_Glasses LOL!

[Gabs_101]

Hold you shares. Do not sell. Paid bashers here to help shorts cover cheaply.

[ckarabin]

Funny how people are still bashing AT&T stock in the blog comments below. Do they know that Batman is an AT&T property? (Time Warner) I'm reading here that it grossed a quarter billion in its first weekend! Yup, that Time Warner is useless! And AT&T shareholders own it.

[Just the Millionaire next door]

@ckarabin They have a lot of properties but never grow the business smh!

[ckarabin]

@Just the Millionaire next door Because the wasted so much capital on their ill fated media adventure. But that's over now, so no sense focusing on the past. Media is gone, under professional media management next month. That in itself is reason to think it will be worth more after the split than it is now. Taking a media business and pulling it away from stodgy telecom guys and putting it under media experts will add value right there.

[Gabs_101]

The Batman by Warner - 248.5m first opening weekend.

deadline.com/...

SUNDAY UPDATE, Refresh for latest…: Warner Bros/DC’s The Batman winged into 74 offshore markets this weekend, landing $120M at the international box office through Sunday. Combined with the $128.5M domestic start, the global launch is $248.5M.

The Matt Reeves-directed Batman was No. 1 in 73 of its openings, and came in at the high end of the range we were seeing ahead of the weekend. The international start is the industry’s best for 2022 (No. 3 for the pandemic when backing out China and Russia) and the biggest for Warner Bros since Joker in 2019, as well as the top international bow ever for Reeves.

[Gabs_101]

Morgan Stanley says AT&T’s WarnerMedia spinoff should ‘unlock value,’ drive upside for stock.

Morgan Stanley has taken a bullish stance on AT&T stock (T -0.7%), with a catalyst-driven take that the upcoming spin-off of its shares for the Warner Bros. Discovery deal will unlock value in communications.

The update comes ahead of AT&T's investor day on March 11, where some additional details are expected on AT&T's Communications business going forward. Discovery's shareholder vote on the deal comes that day as well.

seekingalpha.com/...

www.cnbc.com/...

[Pts117]

@Gabs_101

Yes, it will. This is a $34 stock selling for $24…

[q123we]

"The annual dividend will be slashed to $1.11 per share, representing just over a 4% dividend yield."

You would need to walk me through your math on this. @4.25% dividend you would have a stock price of a little over $26 after the spin.

So $26 a share plus lets say DISCA is trading @$28 so that's ~$7. That makes T worth ~$33 today.

That is clearly not going to happen.

[ckarabin]

@q123we Let's take the current stock price of $23 and assume the spinoff will be worth $7. The AT&T telecom will be worth the other part of only $16, yet will have cash flow of $4.50 per share and free cash flow of $3 per share, paying a $1.16 dividend and yield 7.25%!

Then we can focus on Discovery Time Warner and realize that TW sold for 8x earnings as part of AT&T. Do we really think that it will sell for only 8x after it spins off? Especially when it is producing films that gross a quarter billion in their opening weekend?

[RealRural]

Well Julian, you've hit the highlights and lowlights and summed up the bulls and the bears arguments, which both have some virtue. Will be interesting to see what T's upcoming media session adds to the debate, which will no doubt rage until the merger is completed, and then it's off to the races - or the knacker house.

[canoeistww]

Longtime holder of T and the Bell's before. Have had for decades large holdings in Verizon as well that I added to recently when the share price was in the $52-$50 range as I did with T when it hit the $24-$22 price slump. Also have holdings in Canadian (BCE), British (VOD below $16), French ORAN), German (DTEGY), and Spanish (TEF) telecom. Have long been displeased with T's foray into the decadence of the media-run entertainment industry with the acquisition of Direct TV and Time Warner, the latter of which I was so hoping the U.S. District courts would block, burying the hopes of a merger deep in a well deserved grave. Now that T is divesting itself of this dross and unloading debt on this new media conglomerate I could not be more pleased. May hold these dividend-less spin off shares for 6 months or so to see if they appreciate before purging my portfolio, but I'm not holding my breath in suspense. Don't want to hear anymore about Batman and Super Hero fantasy - only about the core business of telecommunication.

[jamiemcdaniel]

@canoeistww “…I was so hoping the U.S. District courts would block…”

In an alternate timeline the T-Mobile merger was approved and while the DirectTV buy still happened, the Time Warner buy did not. And T shareholders today enjoy a $47 stock.

However in that alternate timeline, there is not the opportunity with T and WBD at low prices that exists here.

[Gabs_101]

Netflix is overvalued by at least 114B.

www.forbes.com/...

Dropped 20% in the last 5-weeks. Will be cut by half in 2022.

Just like you recommended Amazon and Canabis stocks early 2022. Dropped 15% and 30% since.

Besides your key thesis is that WBD debt is high BUT it’s assets are HUGE. In addition you fail to mention that the cost of borrowing 50B is negligible in relative terms to make a firm unable to compete. These are your two critical flaws.

[Gabs_101]

Point 1: Time Warner will most likely be better run as part of Warner Brothers Discovery (WBD). They will have synergies to reduce expenses and increase Average Revenue per User (ARPU) and will be more valuable in this arrangement. We get about 0.24 shares of WBD at DISC valuation per AT&T share which allows shareholders to switch to one or the other based on supply and demand. A no brainer really,

Point 2: Also, I am happy that the dividend is going to be reduced, closer to the industry standard as I would rather have 6 7B per year less dividend payments staying in the coffers and see the money reducing the debt, reinvested or used to buy back stock.

Point 3: T > 54B EBITDA in 2020 and in 2021.

Point 4: Market cap ~ 3 X EBITDA while rates are close to zero.

Point 5: Net debt < 3 x EBITDA.

Point 6: 6B per year ongoing cost reductions.

Point 7: Whatever they are using to invest is to increase earnings in strategically key growth areas.

Point 8: 3B per year in less interest payments (1.6B) as a result of the reduced debt with spin-off and improved credit rating (cost reductions, less debt, less dividends).

Point 9: About 6% for Legacy T @ 19$ in a very low interest environment.

Point 10: Any share price appreciation is on top and above the 6%.

Point 11: Discovery deal is additional gravy here with Malone, Zaslav steering ship. Note Malone outperformed Buffet for many years.

Point 12: IMHO it would be smart to sell the 70% stake in DirecTV for 15B+ and use another 10B of the 43B debt reduction and repurchase 850m shares to drop the float down to 6.3-6.5B shares.

Plus we get 0.24 shares of WBD per shareholder.

T has a P/S ratio of 0.94. VZ a P/S of 1.54 while SHOP's is 72.99, and NFLX's is 9.55

Warner is larger than NFLX that has double market cap than T's entire company. You get for free Legacy T with $20B FCF, focusing on service, paying down debt, buying back shares, and paying decent dividends.

[Gabs_101]

How far from reality. Source below from the NYT:

Netflix announced Tuesday in its fourth-quarter earnings report that it would not “need to raise external financing for our day-to-day operations,” a significant move for the heavily indebted company.

In less than a decade, the streaming giant borrowed over $16 billion to feed its titanic appetite for content. The reason: It didn’t make enough money to cover both its entertainment productions and its business costs, like payroll and rent and marketing.

That fact has caused a longstanding gripe over Netflix’s business model, and it’s why some observers have long argued that Netflix is a debt-ridden house of cards that would eventually come tumbling down.

Daily business updates The latest coverage of business, markets and the economy, sent by email each weekday. Get it sent to your inbox.
Reed Hastings, Netflix’s co-chief executive and co-founder, expected Hollywood would soon catch up in the streaming market, and the company stockpiled content as quickly as possible. To finance the hefty licensing and production costs, it borrowed the money. And kept borrowing.

The risk was clear: If Netflix didn’t generate enough cash by the time the debts came due, it would be in serious trouble. Mr. Hastings was betting that the company could attract subscribers (and raise its prices) faster than the debt clock was ticking. (Netflix was surprised that Hollywood waited years to jump into digital television, giving it an even bigger lead.)

The gambit seems to have worked. The company will still have $10 billion to $15 billion in debt, but it said it now made enough revenue to pay back those loans while maintaining its immense content budget.

Source:
www.nytimes.com/...

[nerd_rage]

@Gabs_101 Hollywood (and opportunistic tech companies) gave NFLX a huge grace period but that period is over. I can't help noticing that in those top ten lists we see, there's a lot of NFLX and some DIS.

But think of all that we don't see on those lists - the hundreds of shows NFLX made to find that one hit vs DIS titles, where there isn't a huge backlog of loser shows that underpin every Loki or WandaVision - and it's obvious that DIS is far more efficient in uncovering their hits. Just stamp Star Wars or Marvel on it, and it's a hit.

That lack of efficiency may prove to be a problem for NFLX eventually.

[Golfortennis]

@nerd_rage Is it really that they are more efficient, or just that they bought franchises, and just tag on to them?

[bobemack]

sell

[Julian Lin]

@bobemack thanks for sharing

[MostlyLong Ranger]

Even a losing team has cheerleaders

[Julian Lin]

@MostlyLong Ranger In Wall Street, especially losing teams have cheerleaders

[toomuchgas]

My feeling is that the Discovery spinoff stock will largely be sold since most T stockholders at in it for the dividend and Discovery will have no dividend.

[Pts117]

@toomuchgas

It could be, but the move will be sitting on both of them for 6-12 months until the market realizes how much cash and income these two businesses are generating.

[Julian Lin]

@toomuchgas this is possible

[pyrotechnic67]

@toomuchgas I think that crowd has already flew the coop.

[truckster]

..."Yet I am skeptical that management will really stick to the game plan of paying down debt and eventually repurchasing shares...". This statement is pure conjecture. T management has clearly stated its goals/objectives for utilization of its prodigious cash flow: debt reduction, dividend increases, business growth investments, and share buybacks. The higher probability than your conjecture is T management sticks to the game plan this time because a) they are fully aware of the mistakes of the past and b) they want to maximize the value of their shares. Given all this, T offers a very attractive risk/reward currently and should be bought/owned at current levels. I am long T shares.

[Julian Lin]

@truckster "This statement is pure conjecture. T management has clearly stated its goals/objectives for utilization of its prodigious cash flow"

There's a track record, so unfortunately this isn't pure conjecture.

[Gabs_101]

@Julian Lin
So presumptuous. The CEO knows he needs to reduce the debt and focus on drivers. That’s what he has been doing. More waste ? that ain’t gonna happen.

[Rick Both]

horribly mismanaged company- stock performance says it all imo!

[Julian Lin]

@Rick Both hard to disagree

[Taniawi]

Since disck is higher price of T…. Should I buy T or disck? Some people say that since disck is higher you will lose value in buying disck? Also the new Batman movie coming out is before the merger and I know they going to make a lot on this movie alone my question is does T get all the money from this movie or does some of it go to disck when they merge. So let’s say Batman sells like crazy does disck profit? Thanks

[Julian Lin]

@Taniawi It depends on the arbitrage. I haven't checked the details, but I'd assume Discovery would offer some discount prior to the merger (but not enough to get me interested)