This article is triggered by AT&T’s (T) surprise announcement on May 17, 2021, that it is going to spin off its media assets into a new separate company.
The reorganization is complex, but one of its outcomes is that AT&T’s dividend will be cut next year. We don’t know exactly by how much, but estimates are in the 40% range.
Since I own T as a dividend-growth stock, T’s dividend and its future in my portfolios will be the subject of this article.
What AT&T Announced
The announcement caught most investors by surprise, because AT&T had spent the past five or six years assembling media and entertainment assets, such as DirecTV and Time-Warner, in an effort to become a content + distribution powerhouse.
The new arrangement completely undoes that strategy.
I’m not going to address everything that is going on, some of which is not even known yet. It’s going to take a year for the parties to fill in details, finalize numbers, and complete the transactions.
What I will do is lay out what I think are the five most important takeaways from the restructuring. My main source is AT&T’s presentation about the announcement (available HERE), supplemented by comments on its investor call and some media commentary about it.
- WarnerMedia and Discovery to combine operations
There is a second company involved in AT&T’s restructuring: Discovery (DISCA). The plan is to combine AT&T and Discovery into a new separate company that they proclaim will be a “global entertainment leader.”
The rationale for creating this new company (which is as yet unnamed, so I will refer to it as Newco), includes the following:
- Unlock significant value for AT&T shareholders by getting the WarnerMedia assets out of AT&T and into a media-savvy company.
- Accelerate the global growth plans of the streaming services HBO Max and Discovery+, supported by what will become one of the deepest content libraries in the world.
- Generate $3B+/year in cost-saving synergies that can be reinvested into content and streaming.
- AT&T shareholders will own 71% of Newco
When the transaction closes (expected in mid-2022), AT&T shareholders will own all of the downsized AT&T plus 71% of Newco, while Discovery shareholders will own 29% of Newco. Newco will contain the WarnerMedia assets from AT&T plus all of Discovery’s current assets.
Here is AT&T’s diagram of the new ownership structure. Note that AT&T does not become a holding company that includes Newco, as has been misreported. Newco will stand apart as a different company. AT&T’s shareholders will own 71% of the new company.
- Newco starts out laden with debt
Note the two black boxes in the lower right of the above diagram. The pro-forma estimate right now is that Newco will own $58 B of debt.
The two diagonal arrows emanating from the AT&T box represent AT&T sending not only its WarnerMedia assets to Newco, but also offloading $43 B of debt to the new company.
That is sort of the same as Newco paying AT&T $43B for the WarnerMedia assets. I say “sort of,” because AT&T shareholders will own 71% of Newco, which is the same as saying that they will still own 71% of those WarnerMedia assets as well as 71% of that debt.
But the debt will not be on AT&T’s books any more, not directly anyway.
For its part, the CEO of Newco (who will be David Zaslav, current CEO of Discovery) says that Newco will have robust free cash flow to support paying down the debt, reinvestment, and financial flexibility.
- AT&T returns to being a pure-play telecommunications company
Spinning off the media assets means that AT&T goes back to being what it was before it began collecting the media assets: A telecom company.
That’s not to be sneezed at. With 5G slowly taking over the industry, AT&T is a big enterprise even without the media assets.
- The company says that its stripped-down structure will provide AT&T the financial flexibility required to be the leader in broadband connectivity across all the U.S. (It is not the leader now.)
- AT&T also says that the new structure will allow its management team to focus on AT&T’s efficiency and effectiveness transformation.
- AT&T also says that the new structure aligns its assets with the appropriate investor base. (To be honest, I don’t know what that means.)
Earliest estimates from AT&T are for low- to mid-single digit growth rates over the next few years in revenues, cashflows, and earnings per share. They highlight the $43 B net debt reduction to come at closing, and they introduce the possibility of repurchasing shares in the future.
AT&T has been a net issuer of shares over the past decade and a net issuer of debt. The following graphs are from Simply Safe Dividends.
AT&T has 20% more shares outstanding now than it had ten years ago. Share issuance has been one of the ways AT&T paid not only for all those media acquisitions but also for additional billions in spectrum auctions needed for its core telecom business.
The other way that AT&T paid for the acquisitions and spectrum was by issuing debt, $43 B of which it will now be offloading to Newco. It is said that AT&T is the most indebted company in the world when measured in dollars (not ratios).
The graph above shows AT&T’s debt picture. After the DirecTV acquisition in 2015, AT&T promised that it would focus on debt reduction, recognizing its drag on the corporation, not to mention the pressure on its credit rating. And indeed AT&T did reduce its debt for a couple of years, until they acquired Time-Warner in 2018.
Once again, after that acquisition, AT&T said it would refocus on lowering the debt, but that didn’t seem to take hold. Net debt has gone up since the acquisition.
Then earlier this year, AT&T needed to spend $23 B+ on “C-band” spectrum necessary to support new, faster 5-G networks. Up went AT&T’s debt again.
You can see the overall problem. AT&T’s telecom business is capital-intensive in its own right, and adding the media acquisitions on top of those capital needs has kept AT&T in a repetitive loop of spending, borrowing, and share-issuance without being able to substantially reduce either its debt or its share count.
Spinning the media assets off into Newco removes (until the next strategic shift) the capital requirements inherent in the media businesses. Maybe AT&T can get its debt more under control, although it will probably need to continue to acquire spectrum to keep pace in that highly competitive business.
- AT&T’s dividend will drop
Here’s the kicker for dividend growth investors. The circled part of the above slide is how AT&T put lipstick on its dividend going forward.
If you do the math, AT&T’s dividend is likely to drop by about 40%, from its current level of $2.08 per share annually to around $1.25. There has been no official announcement of AT&T’s new dividend, although the company has indicated that it will pay its current dividend (which is frozen at its 2020 level) until the spinoff is complete.
Even though AT&T shareholders will receive 71% of the shares of Newco, it is unlikely that Newco will pay a dividend at all, although this is one of the unknowns about Newco for the present time. For context, Discovery paid no dividend.
I think it is interesting that in its presentation, AT&T suggested the possibility of repurchasing shares in the future without saying anything about resuming dividend increases.
How Has the Investing World Reacted?
Investment media, advisers, analysts, journalists, talking heads, and bloggers have produced a spectrum of reactions, interpretations, forecasts, and guesses in the first couple weeks since the announcement.
There has been a small but not insignificant quantity of erroneous information disseminated, mostly (to be kind) driven by haste to get reports out.
Here is a sample of the kinds of headlines that I have seen. The variety and contradiction can be viewed as amusing, but also as AT&T having created a situation that is not immediately obvious how to figure out.
- AT&T’s New Standalone Company Explained in One Word [the word is “debt”]
- AT&T: A Long-Time Bull Is Frustrated But The Deal Could Work Out for Shareholders
- AT&T: The More It Drops, the More I Cry
- AT&T: The More It Drops, the More I Buy
- AT&T’s Ill-Fated Media Play Cost It Both Time and Money
I think it’s fair to say that the reactions divide into two camps:
The bullish camp says that the restructuring will indeed unlock the value of AT&T’s media assets. Most observers agree that AT&T had no idea how to manage creative media assets, and that the strategy to combine content + distribution under one roof was questionable to begin with.
The result for AT&T shareholders, according to the bulls, will be that they own all of the “traditional” AT&T, which can now focus on its core telecom and broadband services, plus 71% of an exciting new media company run by people that understand how to run media companies and compete in streaming.
Most observers seem to be in the bullish camp. However, most observers come at the question the way that most of the financial industry comes at everything: From the point of view of total return (not income return), coupled with a willingness at this early stage to put an optimistic spin on the possibilities of Newco as it wades into the highly competitive streaming wars.
The naysayers focus mostly on the dividend cut. They believe that many (if not most) retail investors own AT&T for steady, high-yield dividend payouts that rose slowly each year. They weren’t buying into a growth story, were not helped by AT&T’s forays into media (which were overpriced and mismanaged), and won’t be helped much by Newco’s accomplishments no matter how good they turn out to be.
The bearish view is summed up by this passage from an article in the Washington Post:
AT&T’s latest reinvention … is bad news for many retail shareholders. The company has long paid a generous dividend, attracting legions of mom-and-pop investors seeking dependable retirement payouts.
But shedding WarnerMedia will shrink annual dividends by nearly half, from about $15 billion to between roughly $8 billion and $8.6 billion, the company said.
AT&T shareholders will own 71 percent of [Newco], so they will benefit from its future growth. But many current AT&T investors didn’t sign up for … a media growth stock. They want reliable income.
The stock market’s reaction reflects, I think, fast-changing views of what it all means as well as what may be a rotation by stockholders into and out of AT&T.
Overall, AT&T’s price has dropped nearly 8% if measured from the previous Friday’s close on May 14. AT&T made its announcement early on Monday, May 17.
Personally, I invest to reach goals, and my reason for owning AT&T was that it fit a spot in my portfolio for a high-dividend, slow-growth dividend-growth company.
The remainder of this article will be presented from that perspective. In other words, instead of presenting positive and negative points about the overall wisdom of AT&T’s restructuring, I will approach things from the narrower view of a dividend-growth investor who is interested mainly in growing income over the long term.
AT&T Is No Longer a Dividend Growth Company
Those of you familiar with my work know that I have a very simple definition for a dividend-growth (DG) company:
- It pays a dividend.
- It has increased its dividend for five consecutive years.
Prior to 2021, AT&T had been a DG company with an unbroken streak of 36 consecutive annual dividend increases.
However, T’s last increase was paid in February, 2020. All of its quarterly payments since then (six of them) have been the same, meaning that its dividend was frozen, albeit at a high yield level.
Earlier this year, AT&T announced that it would not increase its dividend this year, further confirming its frozen dividend. Based on that announcement, AT&T’s DG streak ended in 2020.
Some investors held hope that AT&T would sneak in a little raise later this year to keep the streak alive. With the May 17 announcement, those hopes are dashed. There is no chance that AT&T will dish out a surprise increase later this year.
That means that AT&T’s status as a dividend growth company is over. Its dividend was already frozen, and shareholders now know that in about a year, the dividend will be cut by around 40%.
Some commentators have said that with the new structure, AT&T will be able to resume annual dividend increases, albeit from the new lower dividend rate that will go into effect from the date of the closing next year.
Personally, I don’t see how they can predict that, and anyway, it would take five straight years of such increases to qualify AT&T as a dividend-growth stock again, as far as I am concerned.
Note that, as of this writing, AT&T is still on the Dividend Aristocrats list (maintained by S&P), and it is still in NOBL, the ProShares S&P 500 Dividend Aristocrats ETF that holds the Aristocrats.
I expect T to be removed from the Aristocrats and NOBL sometime between now and when the new deal closes. The information to justify removal already exists.
What I Intend to Do
The advance information about the dividend cut – which will occur when the deals close in 2022 – gives AT&T shareholders months to decide what, if anything, to do with their shares: Hold them, sell them, trim them, or buy more of them.
Variables that may influence those decisions are:
(1) Something may go wrong with the deal.
(2) The prices of both AT&T’s and Discovery’s stocks will change continually over the next 12 months, which may alter investors’ perceptions about what to do.
(3) Terms of the deal may change as the companies continue discussions and work out details. Or, heaven forbid, they may change their minds.
What – if anything – should you do? My recommendation is to base your decision on what kind of investor you are. What are your goals, strategies, and tactics for investing? What are you trying to accomplish?
Since I am a dividend-growth investor, and invest only in DG stocks, AT&T no longer fills my fundamental reason for owning it. It is still a high-yield stock, but its dividend is no longer either growing nor safe. Its dividend payouts will fall by around 40% sometime next year.
Therefore, I intend to liquidate my position and replace it with one or more true DG stocks.
I make that decision in my capacity as the Chief Investment Officer of my own investment business. From that perspective, it really doesn’t matter how well or how badly the future AT&T + Newco perform. The one thing I know for sure is that AT&T is no longer a DG stock.
In my Dividend Growth Portfolio’s business plan, I have seven selling guidelines. The situation with T fits three of them. The business plan has me strongly consider selling if a stock:
- Cuts, freezes, or suspends its dividend.
- Is impacted by significant fundamental changes.
- Announces plans to split itself into 2 companies or spin off a significant portion of its operations into a separate company.
AT&T has done all of the above: It has frozen its dividend; announced a future cut; is significantly changing its structure and business model; and will spin off a significant portion of its operations into a separate company.
So I’m going to sell it. It’s the end of an era for me, but as the saying goes, when the facts change, you should consider changing your mind. I have changed my mind about AT&T’s future in my DG portfolio.
Eleven Candidates to Replace AT&T
In my Dividend Growth Portfolio, I stay invested. So I won’t sell AT&T until I know what stock or stocks I will buy in its place.
I don’t necessarily expect to replace all of AT&T’s annual income with its replacement(s). That’s because AT&T’s yield is currently so high (7.0%), that the dollars I realize from selling my shares will probably not be sufficient to “buy” enough income from other high-quality stocks.
That’s OK. In the grand scheme of things, the overall loss of income will be a small percentage of my total income, and the deficit will hopefully be made up quickly not only by dividend increases from other companies, but also by the income-compounding effect of reinvesting dividends throughout the year.
After quite a bit of research into DG stocks yielding more than 4%, I constructed the following table of potential replacements for AT&T.
In reading the table:
- The top line is T itself, for comparison.
- The QS score column indicates my Quality Snapshot score for each candidate. After T at the top, the rest of the stocks are sorted by QS score.
- The SSD score is Simply Safe Dividends’ dividend safety score. Although that is also part of the QS score, I want to highlight dividend safety, since that’s what this decision is all about.
- The Valuation scores are rough estimates on a 1-5 scale, with 2 being overvalued, 3 meaning fairly valued, and 4 being undervalued.
- The DGP and IBP columns indicate whether the stock is already owned in my Dividend Growth Portfolio or Mike Nadel’s Income Builder Portfolio, respectively.
Quality Snapshots for the Replacement Candidates
These tables – one for each stock – are arranged in alphabetical order. I am including them to show the details behind the Quality Snapshot scores in the previous table of possible replacements.
The following are articles I have written within the past 12 months about the replacement candidates.
Pinnacle West: Dividend Growth Stock of the Month for July 2020
Verizon: Purchased shares April 2021
After AT&T’s announcement on May 17, Jason Fieber wrote AT&T (T) Cuts Its Dividend: What To Do Now (And Two Lessons To Learn). Jason focused on two lessons for investors: The importance of diversification, and not to chase yield. It’s a good article, and I highly recommend it.
I agree with both lessons. While I do not own as many stocks as Jason, I follow diversification guidelines that help minimize the income impact of an AT&T-like event. And I don’t chase yield. I chase quality, as emphasized in my choice of potential replacements for AT&T.
This article is not a recommendation to buy, sell, hold, trim, or add to AT&T or any other stock mentioned. As always, perform your own due diligence. Check the company’s complete dividend record, business model, financial situation, and prospects for the future. Also consider your tolerance for risk, and especially consider how well the company fits (or does not fit) your long-term investing goals.
— Dave Van Knapp
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