For many years, the primary motivation for many investing in AT&T Inc (T), was to gain a steady stream of dividend income. Many investors were content to hold the stock through thick and thin as long as the company provided a robust dividend check each quarter. With a looming cut in the dividend, it is reasonable to question whether AT&T is still a good dividend stock.
Furthermore, an investor in AT&T today will soon hold a position in Discovery (DISCK) (DISCA) (DISCB), a company that does not pay a dividend.
While many applaud the company’s return to its roots, it is imperative to dissect how the deal will affect future returns in both stocks.
First, The Dividend
If you are a long term holder of AT&T, you can be excused for cursing your decision to invest in the company. From the time management revealed their intent to buy DirecTV, T stock registered a low single-digit return, with dividends included. Meanwhile, the S&P 500, without dividends, returned over 130% in that same time frame.
AT&T management perfected the art of buying high and selling low: the company snagged DirecTV in 2015 for $ 67 billion and Time Warner in 2018 for $ 109 billion. In 2021, the spin-off of DirecTV and other video operations went for approximately $ 16 billion, and the deal for WarnerMedia is valued at $ 43 billion.
Add the decision to cut the dividend, and you can understand why the stock has performed poorly.
On the first day of February, AT&T revealed the annual dividend will fall from $ 2.08 per share to $ 1.11. The reduction will occur after the WarnerMedia spin-off. With the current share price ($ 23.51), that leaves us with a yield of about 4.7%. Using projected FCF, we can estimate the payout ratio at about 40%. That appears to be a sustainable sum, but investors should also determine where the growth rate of the dividend is likely to fall.
Management has a range of $ 8 billion to $ 9 billion devoted to paying the dividend, and $ 1.11 a share hits the bottom end of that limit. So far, so good, but the company’s projected growth rate should also be taken into account.
AT&T guides for a CAGR for revenue in the low-single-digits through 2024. EBITDA and EPS are expected to increase at a mid-single-digit CAGR. Therefore, it is reasonable to expect the dividend to grow in the mid single digit range for the next few years, with the possibility that we could see a larger yield should management decide to push the payout to the upper end of the $ 8 billion to $ 9 billion range.
What we are left with is a dividend that is fairly robust, appears to be safe and sustainable, but one that will likely grow at a tepid pace.
AT & T’s diversification into the media business has aptly been referred to as “diworsification.” The related acquisitions resulted in a great deal of debt. However, the company has used divestments and spin-offs to whittle away at that burden. T sold Xandr to Microsoft (MSFT), Playdemic to Electronic Arts (EA), the anime platform Crunchyroll, the Latin American satellite unit Vrio, and spun off DirecTV.
Likewise, AT&T has over $ 152 billion in long-term debt. Management’s goal is to lower its net debt-to-EBITDA ratio from 3.1 at the beginning of 2021 to less than 2.5 by the end of 2023.
We remain laser-focused on reducing debt, and we’ll strengthen our balance sheet by using proceeds from the WarnerMedia transaction to achieve a 2.5x net debt to adjusted EBITDA by the end of 2023.
John Stankey, CEO
One hurdle the company must conquer to lower its debt are the sums required to strengthen its 5G network: AT&T spent $ 23.4 billion last year, and $ 9 billion this year on wireless network spectrum. The moat that keeps new competitors at bay, requires an enormous, apparently unending need for capex to maintain and expand wireless networks, and seems to be the bane of investors.
T has done a good job of reducing costs of late. The company reported $ 3 billion in cost savings in 2021, well along its way to achieve a total of $ 6 billion in cost reductions.
While the company’s progress is laudable, since T shareholders will soon own 71% of Discovery, that company’s debt load must also be considered.
Discovery: The Devil Is In The Details
When the spin-off of the Warner Media assets is executed, AT&T shareholders will acquire 0.24 shares in the new firm for each AT&T share held. Under the terms of the deal, WarnerMedia will retain $ 43 billion in debt. Combined with Discovery’s current $ 14.4 billion in long term debt (LTD), we will have a company with over $ 57 billion in LTD and about $ 3.54 billion in cash and equivalents.
S&P rates Discovery’s debt BBB- / stable, the lowest level of investment grade debt. Management plans to devote $ 20 billion annually to new content, and guides for $ 52 billion in revenue with an FCF conversion rate of 60% by 2023. The company also guides for $ 3 billion in synergies related to the merger.
There is no doubt that the new company formed from the spin off, to be known as Warner Bros. Discovery, will be a powerhouse to contend with in the streaming wars.
A survey by Whip Media determined HBO Max has the highest customer satisfaction level of all streaming services, and it ranks third, behind Netflix (NFLX) and Hulu in terms of the service that would be retained if consumers could only keep one streamer.
Management estimates less than half of discovery + subscribers are subs to HBO Max. This should spur the adoption of HBO Max by many of the company’s current customers. The combined entities also have over 85 million pro forma subscribers.
A few weeks ago, AT&T revealed it ended 2021 with 73.8 million HBO Max subscribers, a figure 800,000 above the high end of guidance. The company added 1.6 million domestic and 2.7 million international subs.
While that appears positive, delving into the company’s numbers results in some concerns. WarnerMedia’s direct-to-consumer (DTC) business, composed primarily of HBO Max, recorded a drop in operating revenue of over 6%.
The decline was the result of Amazon (AMZN) removing HBO from Amazon Channels in Q3, causing five million subscribers to lose access to the service.
… We’re going to be decelerating as a result of Amazon. It is a one-time decline as we move forward and continue to grow subscribers, we would expect that growth from here.
Pascal Desroches, CFO, AT&T
The DTC business suffered negative EBITDA for the first time: expenses stood at $ 2.3 billion while operating revenue was only $ 2.1 billion.
AT&T also recorded a drop in average revenue per user (ARPU). Domestic ARPU fell from $ 11.82 in the third quarter to $ 11.15 in the fourth quarter.
During the Q4 earnings call, when JPMorgan analyst Phil Cusick asked, “Should we expect this to be a sort of negative EBITDA all year?” the question went unanswered.
This all leads me to the following concerns:
Wells Fargo analysts estimate the nine largest media companies will devote $ 140.5 billion to content creation in 2022. That represents a 10% increase from 2021. In 2025, that figure is projected to hit $ 172 billion.
Disney (DIS) is budgeting $ 33 billion for content in 2022, while Netflix (NFLX) is projected to spend $ 19 billion. Now consider that heavyweights Apple (AAPL), Alphabet (GOOG) (GOOGL), and Amazon (AMZN) are also in the ring contending for the title of streaming wars champion.
Warner Bros. Discovery will have an advantage in that it will be focused on streaming, while many of its rivals have a variety of businesses contending for resources; however, there are manifest reasons why competitors should and will devote capex to their respective streaming services.
Last but not least, Warner Bros. Discovery, with a current debt rating that ranks at the bottom of investment grade, will be taking on an additional $ 43 billion in debt once the spin-off is complete.
Will every company involved in the streaming wars prove successful, or will the field eventually be winnowed? In a contest in which content is arguably the secret to success, I contend those with the greatest financial resources have a distinct advantage.
It is assumed subs were bolstered by the release of Warner Bros. films to HBO Max on the same date they appeared in theaters during the pandemic. The company now has a policy of providing a 45-day theatrical window, and it remains to be seen how that might affect churn and new subscriber growth.
Sub growth may be boosted by expansion into foreign markets, but pre-existing distribution agreements leave HBO locked out of the UK, France, Germany, and Italy.
In 2021, AT&T added 3.2 million postpaid phone subscribers, a number that exceeds the prior ten years combined.
AT & T’s communications grew Q4 by 2.4% year-over-year. This marked the fifth consecutive quarter of growth. Equipment revenue increased 6.2% year over year.
AT&T Stock Forecast
T currently trades for $ 24.03 per share. The average 12-month price target of 21 analysts is $ 29.43. The average price target of the 7 analysts that rated the stock following the last earnings report is $ 31.86.
T has a forward P / E of 9.34x. Seeking Alpha provides a 5-year PEG of 2.31x while Yahoo finance calculates the 5-year PEG at 3.83x.
Is T Stock A Buy, Sell, or Hold?
The spin-off will allow AT&T to focus on its core offerings. Furthermore, debt levels will likely fall to a more palatable level.
With nearly 200,000 hours of programming as well as blockbusters such as “Game of Thrones,” “The Big Bang Theory,” and “Friends” to lure subscribers, there is no doubt that Warner Bros. Discovery will be a force to be reckoned with in the streaming wars.The company will also be a pure play content provider, unlike most of its rivals.
However, I question whether Warner Bros. Discovery will have the resources to compete against its titanic rivals long term and still provide a strong profit stream.
I also believe that many of the current holders of AT&T, investors that were attracted to the company due to its hefty dividend, will rush to divest themselves of the shares of Warner Bros. Discovery, a company that pays no dividend, once the spin-off is finalized.
When I consider AT & T’s 5-year PEG ratio, as well as management’s guidance for low to mid single digit growth for the foreseeable future, I do not view the shares as trading at a real bargain.
Consequently, I rate AT&T as a HOLD.
This is an upgrade from my SELL rating which I initiated in May of 2021.
I will add that I view the company as a reasonable investment for those seeking a fairly robust, safe stream of dividend income; however, should I decide to invest in the stock, I will not initiate a position until after the spin-off.