Posted on May 19, 2021 by Bob Ciura
Telecommunications giant AT&T Inc. (T) has long been a dependable dividend staple for high-income investors. AT&T has typically offered a high dividend yield that is well above the market average. In addition, AT&T has increased its dividend every year for 30 consecutive years, securing a spot on the exclusive list of Dividend Aristocrats.
The Dividend Aristocrats are a group of 65 stocks in the S&P 500 Index with more than 25 consecutive years of dividend increases.
You can download a full list of all 65 Dividend Aristocrats (plus key financial metrics like dividend yields and price / earnings ratios) by clicking the link below:
However, AT&T hasn’t increased its dividend in over a year, largely due to an increased debt burden as a result of the spending spree in recent years.
Now AT&T is trying to get rid of many key assets it has acquired over the past several years, including DIRECTV and WarnerMedia, which could have a negative impact on its dividend.
This article discusses recent AT&T mega merger news and the positioning of AT&T shareholders in the future.
AT&T is a telecommunications giant that offers a wide range of services including wireless, broadband, and television. The company currently operates in three business areas: AT&T Communications (providing mobile, broadband, and video data to over 100 million U.S. consumers and nearly 3 million businesses), WarnerMedia (including Turner, HBO, Warner Bros., and Xandr) and AT&T Latin America 11 countries.
AT&T is a mega-cap stock with a market capitalization of over $ 200 billion.
The company took a giant step on May 17, 2021 when it announced an agreement to combine WarnerMedia with Discovery, Inc. (DISCA) to create a new global entertainment company.
Source: Investor Presentation
As part of the transaction, AT&T will receive $ 43 billion in a combination of cash, securities and debt retention.
In addition, AT&T shareholders will receive shares representing 71% of the new company, while Discovery shareholders will own 29%. The company will combine HBO Max and Discovery + to compete in the direct customer business, bringing together names like HBO, Warner Bros., Discovery, CNN, HGTV, Food Network, TNT, TBS and more.
The new company expects sales of $ 52 billion in 2023. The transaction is expected to close in mid-2022.
Perhaps AT & T’s renewed focus on the telecommunications business is an attempt to get back to growth. By separating the media business, AT&T intends to focus on its core competencies again without having to invest in wireless network infrastructure and media resources at the same time.
Still, there is a significant impact for AT&T shareholders, especially high income investors.
Of course, no discussion of AT&T would be complete without mentioning the dividend. As a dividend aristocrat with over 30 consecutive years of dividend growth and a high dividend yield of 7%, AT & T’s dividend is a primary reason investors buy the stock.
AT&T struggled to increase its dividend after acquiring Time Warner. In fact, the company hadn’t increased its dividend per share since December 2019. This actually jeopardized AT & T’s status as a dividend aristocrat. The company would have to increase its dividend sometime this year to remain a dividend aristocrat.
After the merger with Discovery, there is a high likelihood that AT&T will reduce its dividend. If media assets aren’t in tow, sales and cash flow will drop significantly. With AT & T’s financial resources already drained by the increased debt burden, it is unlikely that AT&T shareholders will receive the same dividend payout per share as before.
Upon completion of the transaction, the remaining AT&T business expects low single digit revenue growth, adjusted earnings per share in the mid single digits, annual investments of $ 24 billion, a net debt to EBITDA ratio of 2.6x, and an adjusted Dividend (to account for WarnerMedia’s distribution) ranging from 40% to 43% of free cash flow of over $ 20 billion.
Source: Investor Presentation
This translates into an annual dividend of approximately $ 8 billion (~ $ 1.15 per share) compared to the current annual payment of $ 2.08.
A revised dividend of $ 1.15 per share would translate into a current dividend yield of 4%. This is likely to be seen as a disappointment for investors who are used to getting a high ~ 7% return from AT&T (dividends per share of $ 2.08).
It is possible that shareholders will receive a dividend from the new company after the merger is complete, although investors are not guaranteed of it. For what it’s worth, Discovery doesn’t currently pay a dividend to its own shareholders. Although AT&T shareholders will own nearly 30% of the combined company, the dividends themselves are unlikely to equal the current payout of $ 2.08 per share overall.
Still, we don’t know what value the new company will have in the spin-off. It is possible that AT&T shareholders can sell the spin-off immediately and reinvest the proceeds in the “old” AT&T company in order to maintain their current return on invested money.
An example of how this could work can be found below:
- AT&T currently pays $ 2.08 in dividends per share and trades for ~ $ 29 / share
- We expect AT&T to pay dividends of $ 1.15 per share after the spin-off
- In order for investors to keep their income the same, they must increase their number of shares by approximately 81%
- If the price of the spin-off share at the time of the spin-off is 81% or more of the price of the AT&T share and the AT&T shareholders receive 1 share of the ‘New Company’ for each AT&T share, these are the A & T Shareholders will be able to sell ‘New Company’ shares instantly, reinvest in AT&T shares, and maintain their dividend
We don’t know if this will happen at this point, so it’s too early to say with certainty that after considering the spin-off, this represents a real dividend cut for AT&T. It appears to be a dividend cut, but we can’t be sure until final stock prices are hit.
Reasons for optimism
While high-income investors never want any of their stock holdings to lower the dividend, especially a dividend aristocrat like AT&T, there are reasons for shareholders to be bullish. The new AT&T will be simplified, again with a focus on the core telecommunications businesses that made AT&T the industry giant it is today.
It also means AT&T is likely to have improved financial health with less debt. Investors should keep in mind that debt settlement has been a financial priority for AT&T over the past several years. The mega-merger with Discovery isn’t the only deal AT&T has made. The company previously announced a series of asset sales and other measures, all of which are aimed at deleveraging.
For example, AT&T announced on February 25th that it would spin off a separate company called New DIRECTV, which will own the DirecTV satellite television business, as well as AT&T TV and U-Verse-Video. AT&T will sell 30% of the shares in TPG for approximately USD 8 billion, which will also be used to repay debt.
While AT & T’s dividend cut will be negative for shareholders in the short term, it could pave the way for a return to dividend growth in the future. AT & T’s return to a telecommunications focus could help the company compete better with its strong competitors Verizon Communications (VZ) and T-Mobile US (TMUS), both of which are heavily investing in 5G.
Valuation and expected returns
Our calculations of expected return include three key factors: future earnings per share growth, dividends, and any change in the valuation multiple (indicated by the P / E ratio). We reaffirm our expectations for 3% annual earnings per share growth for AT&T and a fair value of $ 35 per share, unchanged from our previous estimate.
We believe the spin-off could unleash more value than the current company. Therefore, the recent sell-off of AT&T shares following the merger announcement is a potential buying opportunity. With a current stock price of ~ $ 29, a fair value estimate of $ 35 plus the current dividend yield of 7% implies an expected total return of more than 13% per annum. As a result, AT&T stock remains a buy.
AT & T’s announcement that it is outsourcing its media assets into a merger with Discovery is likely to result in a reduced dividend after the deal closes. On the other hand, the various transactions AT&T announced in the past few months pave the way for a stripped-down, more efficient company with improved growth prospects and a healthier balance sheet.
Whether investors should continue to hold the stock depends on the goals of the individual investor. For investors focused solely on current dividend earnings, AT & T’s potentially reduced dividend could be a reason to sell for some, although the stock should still generate a return in the 4% range based on the current share price. This yield equals the dividend yield that Verizon offers. We do not currently view AT&T as a sale as the dividend cut has not yet occurred and the company offers attractive total expected returns at current prices.
Additionally, investors who were also concerned about AT & T’s high debt levels and slower growth may find reason to hold on to the company’s renewed growth potential.
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