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(wow) Words Of Wonders Level 1294 Answers – AT&T (NYSE: T) announced that it will spin off its WarnerMedia division and merge with Discovery, Inc. (DISCA) (DISCB) (DISCK) to create an independent media company with a wide range of content. In the race for audience share, the goal is to compete with the new and exciting Netflix ( NFLX ), Disney + ( DIS ), and Amazon Prime ( AMZN ).
AT&T will offer substantially all of its WarnerMedia assets, as well as $43 billion in debt, to the entity, which will be merged at the same time as Discovery. As a result, the new company will be 29% owned by existing Discovery shareholders and 71% by existing AT&T shareholders. After the deal closes in mid-2022, AT&T will return to the basics of phone and Internet. This is a reversal of actions taken by the company three years ago when it acquired Time Warner. The move will reduce AT&T’s debt to pre-Time Warner levels and allow the company to focus on key growth areas – 5G and fiber deployment.
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With this adjustment comes a major change in capital policy that could make AT&T’s interest rate less profitable. The company announced the dividend policy after the round:
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Amazing deal – extended to WarnerMedia’s distribution history for AT&T shareholders. After closing and subject to approval by AT&T’s board of directors, AT&T expects an annual yield of 40-43% over expected cash flow of $20 billion.
A quick math would show that on average, the annual payout from the new AT&T would be 0.415 x $20 billion = $8.3 billion. Assuming no change in AT&T’s share price, the dividend payout would be $8.3 billion/7.14 billion shares = $1.16 per year or $0.29 per quarter. (The number of shares may vary depending on the balance between the dividend and the exchange offer to complete the series. (I will discuss this below.)
The $0.29 per share is a significant discount from the one-half share of $0.52 per share. However, investors should also consider the value of the shares they will receive and the capital costs of all new companies. To do that, we’ll start by assuming that regardless of how the shares are distributed, Discovery shareholders will already own 29% of the new company, and AT&T shareholders will own 75% of the new company at the time of the merger.
Using Discovery’s current market cap of $22 billion, the new company’s market cap should be $22 billion/0.29 = $76 billion. This means that AT&T shareholders will receive approximately $54 billion in company stock. That’s worth $54/7.14 = $7.56 per AT&T share.
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If AT&T is still trading at $326 before that, the price will drop to $25. The dividend paid is $1.16/$25.70 = 4.5%. That’s lower than AT&T’s current dividend yield of 6.3%, but more in line with Verizon’s ( VZ ) 4.3%. This is also consistent with the manager’s statement in the press release that AT&T expects to be “in the 95th percentile” of distribution. Yes, if you rank the S&P 500 companies by size, you will see that Verizon is about 25th from the top.
That’s bad news for investors who hold AT&T, especially for its largest shareholder. For investors who want to focus on the bottom line, this could be good news because the dividend cut will allow the company to quickly deploy 5G and fiber to increase market share and profits.
Investors may also be disappointed, according to the news company. The company expects EBITDA of $14 million per year in 2023 at a free flow rate of 60%, meaning $8.6 million in FCF. However, it will go a long way to reduce debt, especially for the first few years. With $43 billion in debt from AT&T and $15 billion from Discovery, the new company starts with $500 billion in debt, roughly 58 × 2022 EBITDA. The company aims to grow debt to 3x EBITDA within two years, which means that debt should fall to 14×3 = $42 billion. As you can see, this $16 billion in debt relief in the first two years eats up all of the $8.6 billion in free cash per year.
In addition, there is little incentive for investors to hold a spinoff company unless they are confident in the long-term growth story and believe that the company can become a leading player in today’s market. Eventually they will increase profits, and start making money to distribute or buy.
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The deal has just been announced and other details are unknown. This includes whether the merger will be achieved through a simple share issue, an exchange offer or a combination of the two. In the form of stock shares, AT&T shareholders only receive a pro rata share of the company based on the number of AT&T shares they own. In this example, the number of AT&T shares does not change, and the number shown in this article is correct. On the stock market, AT&T shareholders who want more shares of the newly acquired company can transfer some of their AT&T shares to the four companies in exchange for the shares they want. Any shares remaining after the tender offer will be distributed equally among the remaining shares of AT&T.
In terms of the exchange offer, the dividend looks better for AT&T shareholders, but not by much. In the extreme case, if 100% of the value of the 54 billion preferred shares were distributed through the transaction, the number of AT&T preferred shares would be $54 billion / $33.26, or 1.62 billion shares. This reduces AT&T’s total outstanding shares to 5.52 billion shares, and the new dividend after the round will be $8.3 billion/5.52 = $1.50 per share per year, or $0.375 per quarter. That’s a significant drop from the current $0.52 per share.
In fact, I expect a few dividend-loving AT&T shareholders to participate in an exchange offer that will give them an additional boost. So I don’t expect AT&T’s price to drop that much, which would put my number past anything close. In any event, investors should check the release of the spinoff prospectus to determine the exact terms of the agreement.
AT&T’s view of WarnerMedia and its merger with Discovery represents a major change. This will allow AT&T to return to the basics of providing mobile phone and Internet services and create a major mobile company that can better compete with the media giants. However, those holding AT&T for its share should prepare for a significant decline in post-dividend earnings. Those investors may want to look for other quality stocks, but if they decide to stay in the same business, they will find that the new AT&T needs to have the same rating as Verizon. I look at AT&T as a hold in my portfolio because I don’t want current earnings and I want to give the management time to take advantage of the improvement.the emphasis they have shown in the media.
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I am a chemical engineer by training and hold an MBA with specialization in finance and operations management. I took a job immediately after 22 years in the energy industry in engineering, planning and financial analysis. I have been holding my own since 1998 and I have achieved my goal of matching the return of the S+P 500 over the long term with low lows and high returns. I plan to focus on positions I already hold or am about to change, but I tend to go long unless there is a compelling reason to sell.
Disclaimer: I/we are long T. I wrote this article myself and it reflects my opinion. I do not receive payment for this (except for Seeking Alpha). I have no commercial relationship with any of the companies mentioned in this article.
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