AT&T: Hold On To Your Warner Bros. Discovery Stock (NYSE:T)

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It’s official. On Monday, Warner Bros. Discovery (WBD) will begin trading. AT&T (NYSE:T) shareholders, as of close on Apr. 5, will receive 0.241917 shares of WBD for each share of AT&T held. They will own 71% of the combined company, and AT&T will also receive $40.4 billion in cash on top of WBD’s ownership of certain debt.

Transaction Summary

The transaction is a semi-complex transaction but from a shareholder perspective it boils down to a few key details.

AT&T Transaction

AT&T Transaction

AT&T TimeWarner Transaction – AT&T Discovery Investor Presentation

The Reverse Morris Trust transaction broke out on April 5. For the week it traded with a separate T.WI ticker, and on Friday the transaction closed. On Monday, Apr. 11, the new company will begin trading under WBD. The new company will be 29% owned by Discovery shareholders and 71% owned by AT&T shareholders.

AT&T will receive $43 billion through a variety of different factors which will combine with the acceptance of $15 billion of Discovery debt. Putting it together that means $58 billion in total debt for the company. The current value placed by the market on each share is $24.14/share implying a market capitalization of roughly $58 billion.

Asset Portfolio and Synergies

The combined company has an impressive portfolio and will have the ability to achieve strong synergies.

AT&T Warner Bros. Discovery Transaction

AT&T Transaction

AT&T Asset Portfolio – AT&T Discovery Investor Presentation

The combined company will be available across the world with a massive 200k hours of video content. The company will have one of the largest TV studio and movie studios and will truly be competitive with only Disney (DIS) given the massive size. The company has premium sports rights and numerous impressive assets.

Those assets could drive significant synergies. Expected run-rate cost savings are expected to be more than $3 billion annualized which would be a substantial part of the combined company’s earnings. This unique asset portfolio and synergies are the product of decades of content creation, an asset that’s near impossible to replicate.

Acquisition Interest

And because of those assets, we expect there to be significant interest around potentially acquiring WBD. Specifically from large technology companies. As we’ve discussed before, large tech companies have considered such acquisitions, and we continue to believe it’s a possibly.

Apple and Amazon are both working hard to build new streaming services. Google is doing the same through YouTube TV. All these companies have gotten some traction as a result of their size but have struggled to make significant traction. With Amazon spending $13 billion, and Apple TV+ spending $6.5 billion, the cost of failure is not negligible.

Acquiring TimeWarner would make up 4-6% of these companies’ value, provide profits off the bat, and give them a top-tier streaming services competitive with both Netflix (NFLX) and Disney. TimeWarner alone is already substantially profitable as we will see in the financial picture below, and that doesn’t count synergies. For that reason we expect substantial acquisition interest.

Financial Picture

The financial picture of the combined company is incredibly strong and will help support increased shareholder rewards.

AT&T Transaction

AT&T Transaction

Combined Financial Picture – AT&T Discovery Investor Presentation

The combined company is expected to see revenue expand significantly towards $52 billion in 2023E. $15 billion of that is expected to be from DTC revenue, and with the company’s HBO Max streaming outperforming the company’s growth expectations, in our view it’s likely that the company will be able to breeze past these numbers.

The company expects adjusted EBITDA to grow from $12 billion to $14 billion with a 60% FCF conversion and debt going from $60 billion to $42 billion. That means the company will primarily focus on repaying debt from 2020 to 2024. That’s in line with the company’s long-term leverage targets meaning the potential for substantial shareholder returns starting in 2025.

At that point the company will be at $14+ billion in adjusted EBITDA and almost $9+ billion of FCF. For a $60 billion market cap company with $40 billion in debt that’s sufficient FCF to generate market beating shareholder returns especially with its continued growth. That’s an incredibly strong financial picture.

Sell-Off Opportunity

There is the potential for an additional opportunity here once WBD starts selling. AT&T investors will own 71% of the combined company and there’s a substantial portion who might instead choose to treat it as a $6 per share dividend, selling their new stock. Given the significant shareholdings, that could place substantial downward pressure on the stock.

That downward pressure, as a potential sell-off opportunity, could mean that there’s several unique opportunities to invest in the coming months. We recommend, for those looking to make a new investment, to opportunistically add shares as new opportunities present themselves versus investing all at once.

Thesis Risk

There’s two risks to our thesis.

The first is that streaming is a difficult and capitally intensive market. Plenty of new competitors have entered in recent years and Netflix, for example, has already suffered as a result. There’s no guarantee that HBO Max continues to perform or out achieve its peers, and being unable to do so might hurt the company’s shareholder rewards.

The second is that Warner Bros. management has a history of participating in lofty acquisitions with cultural clashes and a failing to integrate well. There’s no guarantee that the same doesn’t happen with Discovery or a potential future acquirer that hurts the company’s ability to continue providing shareholder returns.

Conclusion

Starting Monday, Warner Bros. Discovery will begin trading separately. With AT&T shareholders receiving 71% of the combined company, many might rush to sell their investments in the company. In our view, we definitely recommend not selling your investments, and if a sell off does occur, we view that as a unique investment opportunity.

Specifically, the combined company will spend the next two years rapidly reducing its debt load and taking advantage of synergies before having significant and growing FCF it can utilize for shareholder rewards. We view that a combination of dividends and share buybacks can overall allow the combined companies to drive double-digit shareholder returns.

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