Not sure if you have had already a chance to read the news today, but AT&T decided to spin-off their Time Warner assets and combine it with Discovery Inc.

The AT&T Time Warner spin-off deal structure is quite vague to me, but this is what many shareholders got used to over the last few years.

But actually, this is a major issue for me, because the lack of transparency is what many fellow investors complain about. If it reminds me one thing, then it is the slow downfall of General Electric from several years ago:

Heavy debt loaded, creating smoke and mirrors in their press releases, but at the same time major write-offs year after year.

But OK, the comparison is not entirely fair, because these are very different circumstances. So what are some of the details of the announcement then?

The Terms of the Deal

Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, AT&T would receive $43 billion (subject to adjustment) in a combination of cash, debt securities, and WarnerMedia’s retention of certain debt, and AT&T’s shareholders would receive stock representing 71% of the new company; Discovery shareholders would own 29% of the new company. The Boards of Directors of both AT&T and Discovery have approved the transaction.
Source: ATT Investor Relations

At first hand you would think: great, AT&T can deleverage. But don’t be mistaken there, because the acquisition price of Time Warner was 85 Bln excluding debt back in 2018.

This means that we’re seeing a whopping 40+ bln asset reduction in just under 3 years!

And you can read about this already in the fine print of the press release:

But honestly, I expect even some more major write-offs on goodwill and such.

What about the dividend?

But that’s not all, because I’m particularly interested in whether the dividend is safe.

Remember, the only reason why I was owning a small chunk of AT&T was their juicy dividend.

It was small, because I knew that they had ample cash flow to cover it, but for me the risk was in their balance sheet. Hence, it felt like a decent risk/reward to me.

The good thing is that the press release mentions their position on the dividend after the spin-off:

AT&T Preliminary Financial Profile Following Completion of the Transaction; Focused Total Return Strategy for Capital Allocation; After Close, Dividend Payout Ratio¹ Expected to be Low 40s%.

After close and on a pro-forma basis, AT&T expects its remaining assets to produce the following financial trajectory from 2022 to 2024:
– Annual revenue growth: low single digits CAGR²
– Annual adjusted EBITDA³ and adjusted EPS⁴ growth: mid-single digits CAGR
– Significantly increased financial flexibility to drive returns to shareholders, including:

— Expected increased capital investment for incremental investments in 5G and fiber broadband.  The company expects annual capital expenditures of around $24 billion once the transaction closes.  AT&T expects its 5G C-band network will cover 200 million people in the U.S. by year-end 2023. And the company plans to expand its fiber footprint to cover 30 million customer locations by year-end 2025.

— Significant debt reduction: Expect Net Debt to Adjusted EBITDA⁵ in the 2.6x range after transaction closes and less than 2.5x by year end 2023.

— Attractive dividend – resized to account for the distribution of WarnerMedia to AT&T shareholders. After close and subject to AT&T Board approval, AT&T expects an annual dividend payout ratio of 40% to 43% on anticipated free cash flow¹ of $20 billion plus.

— The optionality to repurchase shares once Net Debt to Adjusted EBITDA is less than 2.5x.

And there it is, this deal comes with a dividend cut for us.

Based on the above information we can expect an approximate 42% dividend cut as shareholders. The reason for that is simple:

43% of 20 Bln is 8.6 Bln maximum in Dividends to the shareholders. In 2020 the distribution in dividends was approximately 15 Bln USD.

Hence, we’re looking at a dividend cut of minimum 42% from what it is today.

But wait a second?

What about the new company with Discovery? Will it also pay a dividend going forward? Isn’t there then a chance we wouldn’t see a dividend cut?

I’m not sure that the new company will pay a dividend, because I have not seen any evidence in the press release.

What I do know is that they will have a lot of capital expenditures in the upcoming years. I’m saying this based on what I’ve seen happening at Disney.

Hence, I’m not assuming any dividend from the new company with Discovery.

Is the AT&T Time Warner spin-off actually a good deal for AT&T shareholders?

This would be for me a final consideration, because maybe it was just a very lucrative deal?

And this is actually another reason why this deal stinks. The announcement said that AT&T’s Free Cash Flow will be 20 Bln plus going forward.

Just for reference, AT&T’s Free Cash Flow was around 28 bln in 2020 and 2019. 28 bln – 20 bln means a reduction of 8 bln in annual free cash flow with the spin-off from Time Warner.

And yes, that means that this is a very poor deal. In my opinion AT&T is spinning off one of their only main bets for potential double digit earnings growth (HBO Max – global streaming).

And in this case they are pricing the assets at a Price/FCF multiple of a staggering 5.4 (43 bln / 8 bln – back on the napkin calc).

I’m a bit disappointed that they didn’t look for another bidder. Was it that hard to get a minimum of a 10x multiple for selling one of their crown jewels: HBO Max and it’s 200K content library?

I do realize AT&T shareholders are seemingly getting shares in the new company in return for this, but even this is not entirely clear out of their press release:

Hence, if it’s indeed a very cheap deal, then at least you want to get only shares in return so that you can benefit in capital appreciation of the new company with Discovery.

My Final Thoughts and Conclusion about the AT&T Time Warner spin-off

I think that it’s obvious from the title of this article and my tone of voice throughout this post:

I’ve sold my shares.

The reasons why I don’t like the AT&T Time Warner spin-off are threefold:

• at least 42% dividend cut
• very low P/FCF multiple without certainty that we get only shares in return
• I expect some large write-offs coming up

It’s a pity, because I owned some shares for more than a year now and it was paying me a nice 7% dividend.

But that was also the main reason for me to own this tier-4 company and the thesis doesn’t stand anymore.

Having said that, I’m not a person that automatically sells after a dividend cut. But in this case there’s just nothing I like about this deal and it doesn’t build any trust in me going forward.

Remember, I’m preliminary a dividend investor, not a growth or a pure value investor. Some value investors might actually see a nice deal in this.

Last but not least, what is left for me now is to consider a new high-yielder in my portfolio to balance it a bit out with some of the low-yield/high-growth companies (i.e. $MSFT).

My AT&T holding results:
– Average cost price: $29.63
– Dividends collected per share (after tax): $1.768
– Sell price: $32.48

Profit / (loss) on my position:
– $4.618 per share
– 15.6% for a holding period of slightly less than 12 months.

In memorandum (2016 Press Release when AT&T Announcement acquisition of Time Warner.):

“This is a perfect match of two companies with complementary strengths who can bring a fresh approach to how the media and communications industry works for customers, content creators, distributors and advertisers,” said Randall Stephenson, AT&T chairman and CEO. “Premium content always wins. It has been true on the big screen, the TV screen and now it’s proving true on the mobile screen. We’ll have the world’s best premium content with the networks to deliver it to every screen. A big customer pain point is paying for content once but not being able to access it on any device, anywhere. Our goal is to solve that.  We intend to give customers unmatched choice, quality, value and experiences that will define the future of media and communications.

That’s it from my side!

I’m curious to hear from you. Do or own some shares of AT&T? If so, what are your plans, buy / hold or sell?

Yours Truly,

European Dividend Growth Investor