The new merger deal between AT&T (T) and Discovery Holdings (DISCA) has a lot of moving parts — and sell-side analysts have yet to update their models to factor in the positives and negatives, notes Frank Curzio, editor of Curzio Research Advisory.
This creates uncertainty — which will always result in a lower stock price. But the stock's pullback will be short-lived.
AT&T is getting $43B in cash and a 71% stake—worth close to $60B—in the new media company. That puts the value of this deal at $103B, which is $18B more than AT&T paid for Time Warner in 2018. That's incredible, considering most analysts considered the AT&T/Time Warner merger a huge mistake.
New Discovery will have one of the biggest media platforms, with loads of amazing content. It will also spend more than $20 billion on new content every year—more than Netflix (NFLX) and much more than Disney (DIS), which will need to raise tens of billions to purchase new content as it continues to generate less cash flow.
The existing AT&T will return to its roots as a telecommunications company. And it has huge growth potential as it aggressively builds out its 5G network into dozens of new markets. This is where T generates the highest ARPU (average price per user) of all its segments.
As for the dividend cut, this is a great move by AT&T, since this money will be used to help grow the company. It will likely cut the dividend by 50%. This amounts to $8 billion. Based on the current deal structure, this should amount to a dividend yield of around 3.5% — roughly 100% higher than the S&P 500 yield.
As you know... growth companies command much higher premiums (most trade at more than 25x forward earnings). Yet, T is trading at just 10x forward earnings. So the small sacrifice in yield (from 7% to 3.5%) is well worth it to investors, as T will start to see strong earnings growth. This will result in a rerating — and trading closer to 20x forward earnings or more (which would double the stock price).
In short, AT&T is creating huge value from its merger with Time Warner: It will lower its debt considerably (where we will likely see debt upgrades) — it will still pay a yield roughly twice the S&P 500 — and shareholders will own 71% of New Discovery, one of the largest pure-play streaming companies.
T remains a strong buy on this pullback. If you haven't established a full position... I suggest doing so at these levels. If you haven't yet, buy a full position in AT&T up to $32.50 with a 25% hard stop.
