AT&T (T) and Discovery (DISCA) Merger?!

Woah woah woah! What is going on here? AT&T and Discovery teaming up to take on the likes of Disney along with Netflix. 

This is how I imagined the meeting to sign the deal went down.

It was announced that these two companies have aligned on combining their media assets into one company that will be led by Discovery’s Chief Executive David Zaslav.

With all these media mergers, I’m convinced at some point in the future there will just be one media company between Netflix, HBO, Disney, Comcast, and Discovery!

I don’t have a position in Discovery, but do have a position in the long term portfolio in AT&T (1.6% of the portfolio value), so of course this deal was of interest to me.

If I’m being honest I was happy with the initial bump in price this Monday as it was announced. The reason being is AT&T is a slow grower. I don’t expect too much out of the position other than to provide some income and to use it as a source of cash if the markets crash and I need extra ammunition to be able to buy faster growing companies for discounts.

So when AT&T goes up 4-5% that is a big day! My fair value on AT&T is around $37, so if it had gotten closer to that I probably would have sold. Very similar approach with my VZ position, in regards to once it hits the fair value.

As you can see that initial spike in pricing reversed and AT&T has actually gone down as there is this worry over the dividend reduction that has been floated out there. But there is no concrete details on how the dividend going forward would be effected.

Here is what has been whispered about.

“AT&T said its dividend payout ratio, which was around 63% in the previous quarter, will be “re-sized” to account for the distribution of WarnerMedia assets into a new company. The remaining AT&T assets will aim to give shareholders a dividend payout ratio of between 40% and 43%, the company said, based on anticipated free cash flow of around $20 billion.”

That would mean a dividend payout of around $8 billion where they currently payout around $15 billion. So if the statement above held true, then the company would be around a 47% dividend cut. But remember we don’t know if the new company shares would payout a dividend as well.

What We Know:

• AT&T merges its media and entertainment properties with Discovery’s in a $43-billion deal and receive $43 billion in cash, debt securities, and Warner Media’s retention of certain debt.
• AT&T’s shareholders would receive stock representing 71 percent of the new company.
• The combined company is expected to have $52 billion in revenue in 2023, and the companies say there will be $3 billion in cost synergies through the combination. 
• AT&T, meanwhile, will focus its efforts on 5G and fiber broadband.
• The deal is expected to close, pending regulatory approval, in 2022.

At the end of the day I need to know more about the deal specifics in terms of how much will the new company be valued at along with how many shares you are getting in the new company. This way I can try to see if the combined value of new shares plus AT&T shares would be around the same value as I had before. If that’s the case then the whole merger news is more of a neutral event and now gives investors the ability to own the telecom or media side based on their preference for dividends or potential growth.

In a way this deal is just a reorganization and the downside would be all the costs around the reorganization and the fact that it will take time to get it all up and running.

What I Like

• The new streaming company will now have a wider range of intellectual property to be included in a bundled package (It’s all about the content!).
• AT&T is trying to reduce their debt load on the telecom side of the business which would help them reinvest better in the business and not have debt drag on future earnings.
• Both businesses can focus on more specific goals instead of having too many objectives that interfere with one another.

What I Don’t Like

• AT&Ts upper management continuing to screw up deals or get involved with mega deals  and then reversing on it years later. For example they overpaid for Direct TV and then they do this deal with warner bros to later divest the company (decide what you really want!).
• It’s not clear how much the new company will be valued at, if their will be a dividend from the new company, etc. It makes it hard to value the deal without these numbers.

Game plan

Let’s briefly talk about the dividend concern. For one, the deal won’t happen till at least 2022, so the dividend isn’t going anywhere anytime soon. Also if you break the company up and the new company also pays a small dividend then you are getting part of the AT&T dividend reduction back. If the new company doesn’t pay a dividend, but instead reinvests the cash then you are getting more growth or stock price appreciation potential.

This sell off in the name I feel like is an over reaction only because the company is just splitting, but realistically you will own both pieces of the pie. The only thing that really would matter is that now people are seeing AT&T overpaid for Warner Media and are devaluing the stock based on this news. I think the stock price will more than likely rebound a bit from this steeper sell off.

Personally, I’m more excited about the valuation of the new streaming company and how many shares as a AT&T shareholder I will receive.

With AT&Ts larger debt load from the telecom standpoint and what I feel like is lagging behind the likes of VZ in terms of 5G technology, I would rather sell off the telecom side once I get the new shares and put that extra money into VZ as my stable telecom play.

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