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Both AT&T (NYSE:T ) and Warner Bros. Discovery (WBD) have been outperforming the market since the completion of the long-awaited spinoff-merger transaction. As market participants continue to reel on the effects of another record-setting inflation print on risky assets, investors of AT&T and WBD have largely sat back on outperforming gains in the four sessions following the completion of the blockbuster media transaction.
For AT&T, the strong post-close four-day rally is really no surprise. Buoyed by the combination of returning investor confidence following a years-long burden from the miscalculated dabble in media and entertainment, as well as increasing market preference for companies with resilience against a looming economic downturn, the telecom stock has gained more than 8% since finalizing the WarnerMedia unit spinoff on April 8th (+13% peak to trough).
Meanwhile, WBD’s post-close rally started off on a comparatively milder pace. The observed trend was as expected considering the current risk-off environment for growth stocks and anticipated near-term selling pressure from income-focused AT&T shareholders that own 71% of the company post-close. However, WBD’s gains caught up during Wednesday trading as it staged a strong rally with intra-day gains of as much as 14%. The stock led the S&P 500 and tech sector in an uptrend that snapped three consecutive sessions of broad-market declines, as markets “[pared] aggressive bets on Federal Reserve hikes amid speculation that inflation be near a peak”.
As anticipated, the AT&T-WarnerMedia breakup is already doing both parties’ investors a lot of good. On one hand, AT&T is presented with a renewed runway for expanding its 5G and fiber broadband business as it returns focus to its core strength in communications. On the other hand, WarnerMedia is now partnered with Discovery to create the second largest media outlet after Disney (DIS), polishing its tracks towards massive direct-to-consumer streaming opportunities ahead of the fast-expanding digital era.
Looking ahead, legacy AT&T investors who also remain shareholders of WBD are in for an attractive low risk, high reward play. And for income-focused, sole AT&T shareholders – worry not – as dividend yields will remain robust, especially on renewed growth opportunities through fast-expanding 5G and broadband opportunities ahead.
In contrast to historically strong April market performance, equity investors have been largely on edge entering into this year’s second quarter due to burgeoning macroeconomic and geopolitical risks. The return of COVID lockdowns in China and an intensifying war between Russia and Ukraine are adding to supply chain snarls and threatening further price pressures in the near-term, although March inflation of 8.5% has already topped the 1981 record. The latest print on producer price increases also came in at a whopping 11.2%, the highest on record since 2010. The dire macroeconomic backdrop is now “[reinforcing] pressure on the Federal Reserve to raise interest rates more aggressively”, spelling further headache for equity investing.
Surging U.S. Treasury yield following the Fed’s increasingly hawkish comments on tightening monetary policy to quell the highest inflation in four decades are also not boding well for equities in recent weeks. Yet both AT&T and WBD have remained resilient over the recent period of mounting macroeconomic uncertainties.
AT&T remains one of the safest equity investments ahead of a looming economic downturn. Thanks to the advent of mobile internet, the need to stay connected has urged “consumers to treat cell phone services like a must-have utility and will cut other household expenses before they touch their phone bill”. The increasingly essential nature of wireless mobility and internet connectivity services in the post-pandemic era will accordingly reduce AT&T’s churn rates, while sales continue to benefit from a strong demand environment.
Slimmed down operations without noise from a media and entertainment business stifling growth also helps the company reduce costs and focus on one of the largest multi-year 5G and fiber broadband upgrade cycles over the longer-term. This is expected to bolster AT&T’s bottom line and assuage investors’ fear over diminishing margins ahead of rising costs in everything from labour to raw materials used in optical fibers that enable internet to the home.
In addition to a resilient business, AT&T’s industry-leading dividend yield also provides some insulation against any potential market valuation decline, while compensating for record-high inflation. Although AT&T has slashed dividends following the spinoff of WarnerMedia, it was a fair, temporary price to pay for greater upside ahead. The board has approved an annual dividend of $1.11 per share, which approximates 40% of AT&T’s anticipated free cash flows. This settles at the lower range of management’s previously guided post-close dividend pay-out structure of about 40% to 43% on more than $20 billion in projected free cash flows. Based on the stock’s share price of about $19 today, AT&T’s dividend yield still tops 5.8%, which remains on the higher-range compared to other dividend-paying stocks on the broader market while also partially compensating for core inflation (i.e. excluding volatile food and energy price fluctuations) of 6.5%.
The Fed is already amping up its hawkishness on fighting inflation, which is expected to stay elevated for longer due to amassing economic pressures from protracted COVID disruptions and a worsening geopolitical crisis in Ukraine that shows no sign of abatement. Considering the anticipated continuation of market shocks from mounting macroeconomic challenges that remain unresolved, AT&T remains an attractive investment under the current market climate given its predictable business with robust cash flows and an attractive dividend yield.
Considering AT&T’s appeal under the current macroeconomic climate, as well as its robust longer-term fundamental outlook on growing 5G and fiber broadband opportunities, our price target for the stock is set at $24 following the WarnerMedia spinoff. This would represent upside potential of close to 30% based on the stock’s last traded share price of about $19 at the time of writing (April 14th).
The price target is derived based on a discounted cash flow (“DCF”) model that utilizes EBITDA growth at a compounded average growth rate (“CAGR”) of 2.5% over a five-year discrete period based on AT&T’s long-term fundamental prospects and cost structure as detailed in our previous coverage. A WACC of 8.4% reflecting the company’s risk profile and capital structure is used to discount the projected free cash flows, and a 7.4x terminal year exit multiple consistent with observations in comparable peers is applied to the valuation analysis.
AT&T Valuation Analysis (Author)
AT&T Valuation Sensitivity Analysis (Author)
AT_T_Valuation_Analysis.pdf
For AT&T shareholders who are also holding onto the special WBD stock dividend, the compounded upside potential is even more promising. As analyzed in our recent coverage on the WBD transaction, the newly formed media giant has potential to exceed a $100 billion valuation, or $40+ on a per-share valuation basis, based on anticipated 2023 revenues of $52 billion and an industry average forward price-to-sales ratio of 2.0x (compares to current WBD trading price-to-sales ratio of 1.1x). Under this computation, AT&T shareholders who had received about 0.24 WBD shares for each AT&T share owned can expect upside potential of 77% in the near-term based on the pre-spinoff share price.
Warner Bros. Discovery Valuation Analysis (Author)
But as mentioned in earlier sections, WBD is now the second largest media company after Disney – WarnerMedia and Discovery currently command a combined streaming market share of 18.3% compared to Disney’s 25.3% under Disney+ and Hulu. On this basis, the company should trade at a forward price-to-sales multiple that exceeds the 2.0x industry average used in the forecast above, underscoring even greater upside potential ahead. WBD also poses a strong likelihood of accelerated D2C subscription growth following the amalgamation of HBO Max and Discovery+ in 2023 and further penetration into international markets over the longer-term thanks to their combined, industry-leading content library, which further reinforces its bullish outlook.
Warner Bros. Discovery Valuation Sensitivity Analysis (Author)
Combining the two streaming platforms and their content is also expected to enable further price discrimination within the highly competitive on-demand video streaming market. While both HBO Max and Discovery+ currently generate dual revenue streams by offering "ad-lite" and "ad-free" options for their respective global subscribers, the combination of both companies is expected to enable additional tier options - such as films only, sports only, or a premium all-in package - that can cater to different user needs and budgets, and maximize its global share of on-demand video streaming subscription volumes.
Based on observations from ex-WarnerMedia CEO Jason Kilar, more than half of HBO Max subscribers are price sensitive and have chosen the ad-lite tier. The observation is consistent across other streaming platforms, like Disney’s Hulu, as well, which has ad-enabled sign-ups exceeding 60% of its subscription base. The increasing number of video streaming platforms has “triggered much debate in the industry over the maximum number of subscriptions that a consumer may be willing to take on”, especially with dampening consumer sentiment ahead of a potential economic slowdown. Being able to price discriminate will be a key advantage for WBD in differentiating itself and maximizing market share within the increasingly competitive streaming landscape, which will inadvertently bolster its valuation prospects as well.
The breakup of AT&T and WarnerMedia has put the two in a better position than ever before. Although their time together in the past few years has been a culprit to AT&T’s stymied growth, WarnerMedia had a breakthrough with HBO Max under the telecom giant’s leadership, nonetheless. And as the two diverge to their separate business endeavours going forward, AT&T is expected to benefit from reinvestments into growth of its core communications business without the added burden from media and entertainment, while WarnerMedia joins Discovery in becoming a market leader in the fast-expanding D2C video streaming business.
Whether you are a long-time investor of AT&T, a pre-spinoff AT&T shareholder who had also received a special WBD stock dividend, or a new/potential AT&T investor, the telecom stock makes an attractive investment at current price levels still, considering its massive growth horizon ahead of a generation underpinned by connectivity. The current macroeconomic uncertainties also make AT&T a safe haven stock considering its generous dividend yield and predictable fundamental outlook. And if you still possess the WBD shares handed out as part of your pre-spinoff AT&T holdings, the promising prospect of compounded gains within the near-term could make the new media growth stock a favourable addition to the income portfolio.
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Disclosure: I/we have a beneficial long position in the shares of WBD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.