What AT&T's WarnerMedia Spinoff Means for Your Dividends

Shareholders in AT&T (T, $32.24) aren’t quite sure just how to react to Monday's news that the company would essentially undo its $85 billion acquisition of Time Warner – a deal that was widely criticized when it closed in 2018.

Indeed, shares in the blue-chip telecommunications giant popped as much as 4.8% at one point in Monday's early trading. However, those gains were pared back significantly by the early afternoon.

Income investors who have come to count on AT&T's generous dividend (currently yielding 6.5%) might want to hold their applause, however.

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AT&T signaled that it will cut its dividend to reflect the company's smaller size once it spins off its media business into a separate entity.

Based on what shareholders get out of the deal, that’s not necessarily a bad thing. But it does make it all the more important for current and prospective T shareholders to understand the ins and outs of this pending deal, and AT&T's new place in the streaming video wars.

The AT&T-WarnerMedia-Discovery Deal

AT&T and Discovery Communications (DISCA, $35.65) rocked the communications industry before Monday’s opening bell by announcing a mega-deal that would combine their formidable cable and streaming media assets.

AT&T, which says it expects to receive $43 billion between cash and securities in the deal, will spin off WarnerMedia properties such as HBO, CNN, TNT, TBS and Warner Bros Studios. Those properties will combine with Discovery assets such as Food Network, Animal Planet and HGTV to form a new publicly traded company. The as-yet-to-be-named media firm will also own streaming media assets HBO Max and the newly launched Discovery+.

T and DISCA hope that the resulting entity will possess the scale and resources to compete with the likes of Netflix (NFLX) and Walt Disney (DIS) in the rapidly expanding streaming media business.

The new company – which is expected to be formed by mid-2022 – will have some catching up to do. HBO Max and HBO combined have about 44 million U.S. subscribers. Discovery+ has roughly 15 million subscribers. Meanwhile, Netflix has more than 200 million global subscribers, and Disney+ has more than 100 million.

But back to AT&T.

Why Is the Dividend Getting Cut?

AT&T said it expects an annual dividend payout ratio of 40% to 43% from more than $20 billion of expected free cash flow. That implies a total payout of between $8 billion and $8.6 billion.

That would represent a steep drop from the $15 billion AT&T paid in dividends in 2020, when free cash flow – or the cash left over after operating costs and capital investments – came to more than $40 million. Morgan Stanley analyst Simon Flannery points out that it would mark "a nearly 50% reduction from current levels ... and would put the stock on a low 4% (yield)."

Although income investors might have to accept less in the way of dividend income, that doesn't mean this is automatically a bad deal for them.

For one thing, it bolsters T's balance sheet. The telco took on tremendous debt when it acquired Time Warner. As of March 31, AT&T carried net debt of $169 billion.

Some analysts and investors worry that the sheer weight of all that debt hampers AT&T's financial flexibility. Telecoms have enormous capital expenditures. They must continuously expand, maintain and upgrade their networks.

The advent of next-generation ultra-high-speed networks only adds to the cost pressure. Indeed, AT&T spent $23.4 billion on wireless spectrum licenses in the Federal Communications Commission's most recent round of auctions.

And although AT&T is spinning off its media assets, the structure of the deal with Discovery still allows current T shareholders the potential to profit from the growth of streaming media and content in general.

Under terms of the deal, AT&T shareholders will hold a 71% stake in the combined media company, in the form of new shares. Discovery shareholders will own the remaining 29% stake. In return, AT&T will receive $43 billion of cash, debt securities and WarnerMedia’s retention of certain debt. The new media company will carry about $55 billion in debt.

Whether the new media company pays dividends remains to be seen, but it certainly will have higher growth prospects than AT&T. But the eventual spinoff and new shares will force current holders of both T and DISCA to re-evaluate their holdings.

Bank of America Global Securities analysts, who rate T at Buy, are optimistic about what this deal could mean for shareholders.

"Given a choice between acquiring new media assets and spinning out a pure play, we believe shareholders are benefited by the latter," writes BofA analyst David Barden in a note to clients. "A combined entity would have an enhanced ability to offer the widest variety of content to attract the largest possible subscriber base on a global basis."