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Next Tuesday, April 5, shareholders of AT&T (NYSE:T) will receive 0.24 shares of a new company, Warner Bros. Discovery, for every share of AT&T that they own. What should you do with these new shares? What should you do with your existing shares?
With the latest disclosures from AT&T regarding their spinoff/merger of Warner Bros/Discovery (WBD), we can model the pro forma valuation metrics of base AT&T as well as the new Warner Bros Discovery (WBD).
Our conclusion? AT&T is trading very cheaply. Let’s go through the math.
|
Shares (billion) |
Share price |
Value ($ bn) |
||
|
AT&T (current) |
7.125 |
$23.98 |
$170.9 |
|
|
WBD/DISCA |
-1.71 |
@0.24/T share |
$25.02 |
-$42.8 |
|
T (post-spin) |
7.125 |
$17.98 |
$128.1 |
AT&T currently trades at a market cap of $171 billion. The distribution of WBD shares is valued at $42.8 billion in the current market. So the shares of AT&T, post spinoff, should be reduced by roughly this amount. That leaves us $128.1 billion over 7.12 bn shares, or roughly $18/share.
Now let’s compare the valuations of each of these companies. Included are AT&T before the spin, after the spin, and WBD after the spin/merger with Discovery. The net debt figures are from the latest 8-k disclosure, provided on March 28.
|
Shares (billion) |
Share price |
Operating Income ($B) |
Interest Expense ($B) |
Market Cap ($B) |
Net Debt ($B) |
Enterprise Value ($B) |
|
|
AT&T (current) |
7.125 |
$23.98 |
32.7 |
$6.9 |
$170.9 |
$190.8 |
$361.7 |
|
WBD |
2.408 |
$25.02 |
12.1 |
$2.6 |
$60.2 |
$79.6 |
$139.8 |
|
AT&T (post-spin) |
7.125 |
$17.98 |
27.4 |
$5.0 |
$128.1 |
$125.0 |
$253.1 |
|
EV/OI |
P/E (pretax) |
|
|
AT&T (current) |
11.1 |
6.6 |
|
WBD |
11.6 |
6.3 |
|
AT&T (post-spin) |
9.2 |
5.7 |
Please note that the operating income figures are “normalized” figures, reflecting $3B in synergies projected by Discovery management and post the max capex intensity that AT&T expects in 2022/3. As such we can think of these as 2024 projections.
No matter how you slice it these are shockingly low multiples, especially for a company like AT&T. In the case of Warner/Discovery which is facing intense structural competition, I can see how a lower multiple may be warranted. But AT&T is a dominant competitor in an oligopoly amount AT&T, Verizon (VZ) and T-Mobile (TMUS). Yet is trading at an EV/Operating Income of less than 10. By Warren Buffett’s metric of Price to Pretax Earnings, AT&T is trading for just 5.7x, (10x is supposed to be a buy).
What explains this remarkably low valuation?
A messy history of confusing deals
Over the years, AT&T has become infamously known as a company that makes poor acquisitions. The perception is that they have engaged in a series of bad deals that benefitted Wall Street but left shareholders poorer.
Consider this:
After years of focusing on corporate transactions (the ill-fated NCR acquisition, the ill-fated spinoff of Lucent), in the late ’90s, AT&T spent $108 billion to create AT&T Broadband with the acquisition of MediaOne and TCI. Just a few years later they merged these assets into Comcast for $72 billion. A loss of 33%.
The sale to Comcast left AT&T a mere shell of a company. This shell was acquired by Southwestern Bell, which adopted the name AT&T. In 2015, they acquired DirecTV for $67 billion. But last year, they sold a 30% stake valuing DirecTV at $16 billion. A loss of 75%.
A year later (in 2016) AT&T acquired TimeWarner for $85 billion. Now they are about to merge Warner into Discovery in a deal that will net $88 billion for AT&T shareholders ($43 billion assumed debt and $45 billion in DISCA stock). This is actually a slight gain, but it is a paltry gain after 6 years of ownership and years of management distraction.
However, the reputation is not completely deserved. The deals they have made are not as bad as they seem at first glance. For example, back in 2002 AT&T shareholders received the majority of shares in the new Comcast, which has gone up sixfold over the past 20 years.
And DirecTV was massively profitable when it was acquired and AT&T bought it for a fairly low multiple. It has spun off a lot of cash over the past seven years. So the 75% loss in value isn’t the whole story.
TimeWarner has also generated lots of cash and, if Warner/Discovery gets rerated as a Netflix (NFLX)-style streaming company there may yet be big upside for AT&T shareholders that stick with their WBD shares.
But as investors we are ultimately concerned with our shareholder returns. After almost 120 years, the original AT&T met its ignoble end as a mere stub of a stock. Meanwhile the new AT&T has been disappointing. Flat for the last 20 years, averaging a 5% dividend while the stock has gone nowhere. What makes this situation all the more puzzling is that telecommunications is a growth business. In fact the rise of the internet and our connected world has been one of the epic growth stories of our times and, due to its legacy, AT&T has continued to be a powerful brand for all that time. But the strength of that brand hasn’t paid off for shareholders.
This is the kind of history which has given AT&T the reputation as a poor investment, as a serial acquirer that overpays for declining assets to mask its poor operational performance. It is an unfair characterization of the company, for the reasons described above. But it is nonetheless a welcome change to see in the latest Investor Day presentation that the company is focused on operating performance and organic growth.
Less moving parts and a renewed operational focus will drive a rerating of shares
Over the next 2-4 years, I expect AT&T to focus on its operating performance and using its free cash flow to improve its balance sheet. In my view, the company should be able to achieve free cash flow per share of $3.00 within a few years (after 2023). If the shares haven’t rerated by then, management will be in a good position to repurchase shares which will be very accretive for shareholders.
What to do with the WBD shares? Well as you can tell from the analysis above, the new Warner Bros Discovery will be extremely cheap as well. Whether you keep WBD shares must depend on what you think of the future of the company. For the reasons I touched on earlier, I believe that core AT&T is a cheaper, better business than the new Warner Bros./Discovery.
On the other hand, there are several opportunities for WBD management to improve operations. One compelling opportunity they have will be to put together a compelling streaming bundle and market it internationally. Warner Bros. has been prohibited from this by carriage contracts they have with overseas distributors. As those contracts end, this is a significant opportunity. Looking further they might turnaround the collapsing CNN. Or they might start to make better movies around the valuable properties of the DC Universe. If the company put together some operating momentum and if it was rerated to Netflix type multiples of 6x EV/Revenue, then WBD could trade at $75 per share.
Basically, the new AT&T will be a safe, undervalued telecommunications company. The new Warner/Discovery will be a riskier play but with more potential upside.
Regardless of what you decide to do, after 20 years of stagnation, the future of AT&T shares finally looks bright.
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