AT&T’s WarnerMedia Unit And Discovery Are Close To Finalizing Their Blockbuster Merger

AT&T's WarnerMedia Unit And Discovery Are Close To Finalizing Their Blockbuster Merger

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The blockbuster merger of WarnerMedia, currently a part of AT&T Inc ( T ), with Discovery Inc ( DISCA ) ( DISCB ) ( DISCK ) is getting closer to completion. On March 11, Discovery shareholders voted to proceed with the transaction which is now expected to close in April 2022. AT&T does not need to secure shareholder approval through a vote to close the transaction. Let’s dig more into the details of this deal. Announced back in May 2021, the blockbuster merger of AT&T Inc’s WarnerMedia unit with Discovery Inc is expected to close in the second quarter of 2022. Overview

Shareholders of Discovery will own ~29% of the equity of the enlarged entity, dubbed Warner Bros. Discovery (‘WBD’), and AT&T will own the remaining ~71%. AT&T plans to conduct a tax-free spinoff to its shareholders of its equity in WBD, distributing 0.24 share of WBD for each share of AT&T. We appreciate that Discovery plans to consolidate its share structure into one class of common stock as part of this process.

AT&T intends to reduce its annualized dividend to $1.11 per share ($0.2775 per share on a quarterly basis) down from $2.08 per share currently ($0.52 per share on a quarterly basis) after the merger closes. This pending payout cut has stung investors, as has AT&T’s deal making over the past decade. AT&T pivoted from “empire building” (acquiring DirecTV in 2015 and Time Warner in 2018) to streamlining its operations in less than a decade.

The firm sold a 30% equity stake in DirecTV and other US video businesses in 2021 through a transaction that effectively split that operation from its core telecommunications businesses. In our view, this move set the stage for AT&T to potentially further wind down or even exit its DirecTV position in the coming years. Now, AT&T is getting close to parting ways with the assets of Time Warner. AT&T

Though AT&T is a cash flow generating powerhouse, the company is contending with several hurdles that ultimately led management to decide to cut its dividend, despite reiterating its commitment to the payout as early as last year.

At the end of December 2021 , AT&T had $178.6 billion in total debt (inclusive of short-term debt) which was moderately offset by $21.2 billion in cash and cash equivalents on hand. While the Discovery deal is expected to generate ~$43 billion in proceeds for AT&T (cash, debt securities, and WarnerMedia retaining certain debt), its net debt load would remain onerous and its annual financing expenses will continue to eat up cash flow.

AT&T spent $6.9 billion covering its interest expenses in 2021, down from $8.4 billion in 2019 but clearly still a major cash flow drain. Interest rates have been steadily climbing higher in recent months, which is putting upward pressure on the outlook for AT&T’s future annual financing expenses.

Last year, AT&T generated over $25.4 billion in free cash flow as $42.0 billion in net operating cash flow easily exceeded $16.5 billion in capital expenditures. However, AT&T expects that in order to support the ongoing development of 5G wireless networks in the U.S. along with efforts to aggressively grow its fiber internet service provider business in various domestic markets, it will need to boost its capital investments in the coming years.

AT&T had this to say in a press release when first announcing the merger in May 2021: 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. Rising capital expenditure expectations at its core operations combined with the pending loss in cash flow from its spinoff of WarnerMedia and other recent divestments (such as selling a sizable stake in DirecTV) forced AT&T to make a decision. As its balance sheet is bloated, AT&T is clearly cutting the dividend to preserve its financial flexibility.

Companies with large net cash positions can use their balance sheet to help cover their dividend obligations. On the other hand, companies with large net debt positions effectively have financing concerns competing with their dividend programs for capital, which can slow the pace of dividend growth, or even worse lead to dividend cuts.

On March 11 , AT&T hosted its big investor day event. The firm noted that it aimed […]

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