What AT&T's WarnerMedia Deal Means for Shareholders

AT&T T provided final transaction details for the planned Warner Bros. Discovery venture, with shareholders receiving 0.24 shares in the new firm for each AT&T share held. AT&T will pay a dividend of $1.11 per share, at the low end of the $8 billion-$9 billion annual payout range management targeted. The spin-off terms will likely disappoint some shareholders hoping for an offer that would have allowed shareholders to take more or fewer Warner shares based on preference. AT&T still believes the deal will close in the second quarter. While the spin-off could create market turbulence as shareholders buy or sell shares in each entity to reshape their positions, the underlying fundamentals of the two firms aren't affected. Thus, our $35 fair value estimate is unchanged. Management reiterated its $20 billion annual free cash flow target following the spin-off. We remain skeptical of this figure. AT&T expects to generate $23 billion free cash flow in 2022, but this includes $3 billion from WarnerMedia and $4 billion in distributions from DirecTV. We doubt DirecTV will be able to sustain anything close to that payout level. AT&T has preferential access to DirecTV cash flow in 2022, but we expect DirecTV will continue shrinking in the years ahead. Management believes future cost-cutting efforts will fall to the bottom line rather than be reinvested in the business. The free cash flow targets are also difficult to interpret. AT&T exceeded its $26 billion 2021 free cash flow target but made heavy use of vendor financing to get there. Absent vendor financing and preferred distributions, which provides a better picture of cash flow to equity holders, we estimate free cash flow was about $19.1 billion. For 2022, AT&T expects continued heavy use of vendor financing. We believe accelerating network investment is the right decision, but we'd like to see management provide a clearer picture of how it plans investment to evolve rather than attempt to hit an arbitrary cash flow target.

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