An AT&T store on Sixth Avenue in Manhattan.
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Spin or split?
That is the decision that AT&T (ticker: T) faces as it considers what to do with a 71% stake in Discovery (DISCA) that it will receive when it merges its WarnerMedia business with Discovery in a deal that could close early in the second quarter.
UBS analyst John Hodulik wrote in a recent note that he believes AT&T “is leaning toward a split of the asset”–an exchange of AT&T stock for shares in Discovery, which will change its name to Warner Brothers Discovery. The deal, he added, could be a catalyst for AT&T stock, which has rallied this year after a poor 2021.
AT&T shares are nearly 9% higher, at $27, so far in 2022. Hodulik has a Buy rating and price target of $34 a share on the stock.
A spinoff would be straightforward. AT&T would distribute an estimated 1.7 billion shares of the merged company to its shareholders, who would get nearly 0.25 share of Warner Brothers Discovery for each AT&T share. Such a move would be worth about $7 per AT&T share based on Discovery’s recent price of $30. Discovery stock is up over 20% in 2022, making it one the top stocks in the S&P 500.
The other option—a split-off—is more complicated. AT&T would offer holders the option of swapping their AT&T stock for Warner Brothers Discovery stock. To entice conversion, AT&T would likely offer its investors a bonus, with Hodulik suggesting a deal of one share for one share.
That would be appealing to AT&T holders since Discovery now trades roughly $3 a share above AT&T stock.
The benefit of a split-off is that AT&T could retire about $45 billion, or 1.7 billion of its roughly 7.2 billion shares outstanding. Hodulik says the AT&T dividend, now 7.8%, likely would be close to 6% in either scenario after the deal based on the company’s prior financial guidance.
Another benefit of a split-off is that AT&T holders could choosewhether they want to hold AT&T stock or swap it for Warner BrothersDiscovery. A benefit of a spinoff would be that all AT&T holders wouldget Warner Brothers Discovery shares and be able to participate in anygains in the media company’s stock.
Some analysts think a split-off is more likely than a spinoffbecause of the ability of AT&T to potentially retire almost a quarter ofits stock at a low valuation.
Kannan Venkateshwar, a Barclays analyst, last month called asplit-off “the most obvious way to go in terms of deal structure.”
In a spinoff, the new dividend would be about $1.18 share while it would be around $1.55 a share with a split-off, Hodulik estimates. The yield would be slightly higher in a spinoff scenario.
Hodulik sees AT&T as attractively valued at about six times projected 2023 earnings of $4.43 a share in a split-off scenario, a discount to rival Verizon Communications (VZ), at nearly 10 times projected 2023 earnings and a 4.7% dividend yield.
Asked about the spin-versus-split scenario, AT&T CFO Pascal Desroches was noncommittal at a December conference appearance: “We think both are great ways to do — both a split and a spin are great mechanisms for delivering value. And we’re not going to make the decision until we get closer to the time of the separation to ensure that we have complete information, including the relative share prices of the two entities.”
Hodulik wrote: “We believe clarity over deal structure and the improved visibility over EPS, FCF (free cash flow), and dividends per share will be a catalyst for AT&T shares, while an exchange structure would enable shareholders to determine their own exposure to Warner Bros. Discovery. We believe AT&T will emerge from this transaction as a leaner, more focused entity better able to invest in its core connectivity businesses.”
Write to Andrew Bary at andrew.bary@barrons.com
