The spinoff
In February, AT&T announced that it would spin off WarnerMedia in a $43 billion deal to merge its media assets with Discovery (DISCA).
AT&T shareholders would own 71% of the new Warner-Discovery company, receiving 0.24 Warner-Discovery shares for every AT&T share they own.
Management also said that it would pay a post-close annual dividend of $1.11 per share, down from the $2.08 per share it currently distributes.
Flannery points out that the new Warner-Discovery shares are currently worth about $6.75 per AT&T share, implying that the remaining AT&T business is valued at $16.78 per share at the moment. So the new dividend payout — while lower than before — will lead to a pro-forma yield of 6.6%, making the remaining AT&T company one of the highest yielders in the S&P 500.
The transaction is expected to close in Q2 of 2022.
Flannery sees the stock reacting to this transaction in three possible ways.
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In the upside scenario, investors quickly gain confidence in the sustainability of AT&T’s revenue growth and free cash flow/leverage outlook, propelling the stock higher on a positive “re-rating.”
Morgan Stanley assigns a 20% possibility to this outcome, where the remaining AT&T business would command a stock price of $20 (post-spinoff), implying upside of about 14%.
The midline
Flannery’s second scenario focuses on the removal of reluctance.
Some investors might be unsure about buying AT&T shares today because they don’t want to own the new Warner-Discovery company. Income-seeking investors, for example, may only want exposure to the remaining fat-dividend-paying AT&T.
But once the transaction is complete — and management updates their outlook — we could see incremental buying from investors who were previously standing on the sidelines.
Flannery thinks the post-spinoff AT&T would trade at $18.50 per share in this midline scenario, implying roughly 7% worth of upside. He pegs this possibility at 50%.
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In the least bullish scenario, Flannery sees investors underwhelmed by the transaction and doubtful about whether AT&T can achieve its targets on deleveraging and free cash flow. Increasingly intense competition in the wireless space would also weigh on investor sentiment.
In such a scenario — Flannery gives it a 30% likelihood of happening — he sees the post-spinoff AT&T fetching a price of $16.25 per share, implying a downside of 2%.
The bottom line
Morgan Stanley isn’t the only firm with a bullish outlook on AT&T.
Barclays has maintained an overweight rating on the shares with a price target of $28 — the same as Morgan Stanley’s. UBS has a buy rating on AT&T and a price target of $32, roughly 32% above current levels.
Of course, the overall stock market is having difficulty finding upward momentum at the moment. Both the S&P 500 and the Nasdaq are in correction territory, down 12% and 18%, respectively, in 2022.
Proceed with caution.
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