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.

Transaction overview

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.

Dividend analysis

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:

  1. AT&T currently pays $ 2.08 in dividends per share and trades for ~ $ 29 / share
  2. We expect AT&T to pay dividends of $ 1.15 per share after the spin-off
  3. In order for investors to keep their income the same, they must increase their number of shares by approximately 81%
  4. 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.

Final thoughts

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.

Thank you for reading this article. Please send feedback, corrections, or questions to [email protected]


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