Morgan Stanley says AT&T is an ‘attractive risk/reward’ tradeoff right now and could see a quick 20% pop — here's why

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.

How to get a free $10 to invest in your future

Sponsored

An app called Acorns automatically rounds up purchases made on your credit or debit card to the nearest dollar and places the excess "change" into a smart investment portfolio. You get $10 immediately from your first investment.

Get $10

The upside

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%.

4 Ways to Become a Millionaire

Sponsored

Most people don't realize that with the right moves, you can become a millionaire — it's not a question of "if," it's a question of "when."

Read More

The downside

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.

Sign up for our MoneyWise newsletter to receive a steady flow of actionable ideas from Wall Street's top firms.

More from MoneyWise

• 4 ways to earn big returns in 2022 without the shaky stock market
• Jim Rogers: Next bear market will be ‘worst in my lifetime’ — he'll rely on 3 assets
• Robert Kiyosaki says we're already in a 'technical depression' — he's using these 3 assets for protection