Yesterday, I said I’d discuss some of the biggest myths about the market.
Honestly, that story can wait.
You see, a huge blockbuster happened Monday.
And I need to discuss it. It’s too important to too many investors to not.
You might own the impacted stocks. And if so, read on.
On Monday morning, AT&T Corp. (T) formally announced it would spin off its Time Warner media assets with Discovery Communications (DISCA) to create a new media giant.
AT&T would receive about $43 billion in cash as part of the deal.
And T shareholders would receive 71% of the new company.
It sounds like an incredible deal for AT&T, right?
Well, Wall Street felt otherwise after a bombshell announcement after the deal.
What is it About Time Warner?
What is it about the name “Time Warner?”
Every time this media division gets involved in a deal, it seems to end poorly.
The most famous is the Time Warner merger with America Online.
In January 2000, AOL said it would purchase Time Warner for $182 billion in stock and debt. At the time, it was the largest corporate merger in U.S. history.
It is also considered one of the biggest M&A failures of all time. AOL was a new, digital company with online channels and content. Time Warner was a relic of the past — full of print magazines and legacy media outlets.
The companies struggled to merge cultures. And then the dot-com bubble burst, driving AOL’s market cap from $226 billion to around $20 billion in a short time.
Fast forward to 2016.
AT&T, best known as a legacy provider of phone services and wireless communications, jumped headfirst into the entertainment business.
The company wanted to compete in television and made an ill-advised purchase of DirecTV, which operates satellite television networks.
AT&T paid $48.5 billion for the satellite provider in 2015. However, the second half of the previous decade coincided with a huge shift in consumer sentiment around television. With mobile broadband speeds increasing at a breakneck pace, more consumers were turning to streaming networks. Netflix had 30.4 million subscribers in 2012. By 2017, that figure topped 110 million.
AT&T hadn’t accounted for this digital trend. (They would turn around and sell a significant stake of DirecTV in 2021 to a private equity firm. Now valued at $16.25 billion, DirecTV represents about a $32 billion loss on paper).
AT&T proceeded to do what it does best, with streaming on the rise.
It chased another deal.
In 2016, it announced an $85.4 billion offer for Time Warner and its roster of networks like HBO and Showtime. This deal would propel it into the future and give it a competitive advantage against emerging threats like Netflix and Hulu.
Or at least that was the plan.
The Problem with The New Merger
Initially, Wall Street praised AT&T for spinning off Time Warner into a new company on Monday.
On paper, the deal looks terrific. It would create a new company that combines Time Warner’s digital channel roster with those of Discovery Communications.
The latter company is behind a huge roster of television channels and assets like Food Network, HGTV, TLC, Discovery, Eurosport, and Animal Planet.
In addition, AT&T would receive a payment of $43 billion, which would help offset its losses on DirecTV and help it address other debt.
But dig under the hood, and the details weigh heavier than the headlines.
AT&T has long been an attractive dividend stock among investors. Last year, pundit after pundit told investors to back up the truck and invest in AT&T stock when its dividend touched north of 7%.
What too many investors didn’t know was that AT&T was saddled with debt.
And that debt threatened the health of that promised dividend. The company’s debt topped $160 billion in March 2021, up from $153.8 billion at the start of this year.
Yesterday, the company’s dividend sat at 6.2% due to an uptick in the stock over the last few months, offering great potential to reinvest those dividends and collect more stock.
But this deal would end AT&T’s dominance as a high-yield darling.
Reports indicate that AT&T would have to cut its dividend to support the deal. Before, AT&T had a 12-month trailing dividend payout ratio of 58.26%, according to MarketBeat. The dividend ratio represents the amount of free cash flow that a company pays out as dividends to investors in relation to its net income.
But this deal changes the dividend dynamic. While AT&T shareholders would receive 71% of a “fast-growing media company” in a spinoff, it’s still premature to know how customers will react.
AT&T said that it expects an “annual dividend payout ratio of 40% to 43% of anticipated free cash flow of $20 billion-plus.” That figure could be optimistic as well, as the company continues to face its crushing debt.
AT&T currently pays about $15 billion a year in dividends, according to Kiplinger. But the new deal will see the firm slash that figure down to between $8 billion and $8.6 billion in the year ahead. That’s a 40% cut.
By those calculations, we could see that 6.2% dividend fall to as low as 4%.
Shares of AT&T rose as high as $33.88 on Monday, a 52-week high.
But once details around the dividend cut hit analysts’ desks, the selloff started.
Shares have dropped by more than 14.1% from Monday’s high to 1 p.m. Eastern on Wednesday when shares traded at $29.10.
Naturally, critics have bashed the deal.
Jim Cramer has been the most vocal. He said that AT&T engaged in “destruction of value” and that the spinoff is “not a transformational deal.”
As much as I disagree with Cramer on things, it’s hard to disagree this time.
The Next Threat to AT&T
AT&T has long been a trap for investors. It has immersed itself in promising technologies like 5G, the Internet of Things, and digital streaming channels. However, it has lagged the S&P 500 over the last five years by a wide margin.
In addition, it has been in the Red Zone on TradeSmith Finance since March 12, 2020. At the time, the stock stopped out at a level very similar to today’s price.
It never recovered. Although it might have been an attractive dividend stock, it has not yet received a buy signal from our system.
We will continue to monitor AT&T and its upcoming spinoff. However, for now, we’ll sit tight and be glad we were able to avoid this drama.
I’ll be back tomorrow with more market commentary. And I’ll have the start of my series on market myths for you very soon.
Enjoy your Wednesday!