By Maen Soufi, Equity Analyst
AT&T (NYSE: T) spent the better part of the last decade pursuing a strategy of vertical integration by acquiring firms that create and produce content with the goal of making its wireless products and services more appealing by adding exclusive content to its packages. Major acquisitions included DirecTV for $49 billion ($67 billion including debt) in July 2015 and Time Warner Inc. for $85 billion ($109 billion including debt) in 2018. This shopping spree has been a colossal failure. Eventually under the leadership of John Stankey, who played a big role in the acquisitions of DirecTV and Time Warner, AT&T began to recognize the strategic failure of their acquisitions. In August 2021, AT&T spun-off DirecTV, leaving it under the management of TPG, a private equity firm, selling 30% of DirecTV shares to TPG while retaining the remaining 70% with a valuation of the new company at $16.25 billion. AT&T is also expected to complete a spinoff of Time Warner, merging it with Discovery in the 2nd quarter of 2022. In this piece I am going to explore the context of these spinoffs, the direction of AT&T’s strategy going forward, and the prospects of the resulting companies especially as it all pertains to AT&T as a dividend pick going forward.
Why Did It Go Wrong for AT&T?
In the 6 years of management by AT&T, DirecTV lost nearly 10 million subscribers. Although DirecTV had already been losing subscribers at the time of its purchase, the losses under AT&T were far beyond both what was expected and what was experienced by other major TV providers. One of the problems was that AT&T wasn’t able to find tangible synergies in its offerings. To work out the merger debt, AT&T raised prices on subscribers multiple times, and the $15/month offer that AT&T proposed to get the Time Warner deal approved went away as well. As customers were paying continuously higher prices, and the quality of internet-based streaming began to outpace that of the DirecTV satellites, it became clear that the acquisitions did not create any significant value through synergies.
Divesting Seeks to Realign Shareholder Messaging
Part of the problem with the acquisitions of Time Warner and DirecTV was that investors in AT&T were expecting a different trajectory for its future. Here you had the world’s largest telecommunications service provider and the single largest provider of mobile telephone service in the US. AT&T’s core business is in communications and mobility, and this business has matured. Very little was expected to be able to disrupt the big service providers and they are even still largely undifferentiated. Many investors were drawn to AT&T because it has paid a strong dividend since 1984 and has been the best dividend payer of the firms in its industry. After such a long period building dividend expectations as a matured business, AT&T suddenly veered into a strategy of pursuing digital media and entertainment that requires heavy capital investment in an incredibly competitive industry. While many streaming services have seen subscriber growth, few have seen much tangible profit. The expensive adventure into the movie business did nothing to help grow the dividend. This is not appealing for AT&T’s traditional shareholder base of “slow but steady” income investors. In fact, those who invested in AT&T in the last 10 years with the expectation of seeing reliable returns have been very disappointed as the dividend payments have been offset by the loss in value of the stock.
The State of AT&T Stock and Dividend
AT&T, currently trades at $23, down a further 27% from the same day two years ago when the covid-induced correction slashed the market. AT&T currently pays a quarterly dividend of $0.52 at an annual yield of 7.7% at the time of announcement. While this yield is high, it follows that AT&T has until now only raised or maintained its dividend over the period of the last 5 years as the stock price steadily dropped. Following the Warner Bros. Discovery deal, AT&T has announced they will be trimming their dividend to an annual $1.11/share coming out to around 40% of their projected free cash flow. This would be considered to be a very conservative and safe ratio of dividend payout to free cash flow.
This announcement would mean that, immediately upon the spinoff, legacy AT&T shareholders will be getting a dividend yield between 4 and 5%, (depending on where the share price settles after the transaction.) This reduced number is still one of the higher dividends in the S&P 500.
This is part of the correction strategy that AT&T management is pursuing to meet its goal of a net debt to EBITDA ratio below 2.5 by 2024. They are seeking to achieve this by investing would-be dividends into debt repayment, having to reconcile the debt taken on to complete the initial purchases, as spinning off Time Warner still leaves AT&T with a sizable investment loss. So the new AT&T will offer a reduced (but still substantial) dividend, rendered safe by an aggressive debt reduction program and conservative pay out levels relative to free cash flow. Rather than creating content, the new version of AT&T will attempt to grow organically by capitalizing on the opportunity of 5G communications.
Still An Unclear Picture
What I recommend for those interested in AT&T depends mostly on your level of risk tolerance. I believe that AT&T is finally getting back on track to provide some significant upside potential, its business outlook is looking strong, and its dividend yield is continuously strong, but those unwilling to play the stock price, those who prefer the safety and comfort of regular dividend checks, it may be a good idea to hold off on a big AT&T buy for the time being. Historically, companies who have cut dividends after big divestitures have mixed results. While the dividend is secure, no one can predict what will happen to the share price after the spinoff.
I am optimistic about AT&T, but the dividend will been cut pretty significantly. I believe there will be a push to grow the dividend again once debt levels are where management wants, but I don’t think now is a good entry point for dividend-seeking investors. It may be safer to wait until the smoke clears and the trajectory of AT&T’s momentum is more transparent.