Everyone makes mistakes, but the mark of a superior investor is the ability to quickly cut off your losses and move on.
AT&T Inc. (T, Financial) seems to have admitted that its foray into media (and the hard-fought acqusition of Time Warner Media) has been a failure, as evidenced by its decision to sell this part of its business and move on. AT&T's new CEO, John Stankey, is the same executive who headed AT&T's diversification into media, but he quickly reversed the decision after he became the CEO.
The transaction is structured as a Reverse Morris Trust transaction, with AT&T to split out Time Warner Media which will then merge wth Discovery Inc. (DISCA, Financial). Discovery will contribute 100% of its business to the transaction and receive 29% of common equity. AT&T will receive $43 billion (subject to adjustment) in a combination of cash, debt securities and Time Warner Media's retention of certain debt. AT&T shareholders are to receive 71% of common equity distributed via shares of stock. David Zaslav, the current CEO of Discovery, will head the newly combined company.
Note: A Reverse Morris Trust in United States law is a transaction that combines a divisive reorganization (split-off) with an acquisitive reorganization (statutory merger) to allow a tax-free transfer (in the guise of a merger) of a subsidiary to another company.
The new company (which has yet to be officially named) will become the third-largest media company behind Disney (DIS, Financial) and Netflix (NFLX, Financial). It will focus on content, not transmission or technology. It will have media brands like CNN, HBO Max, March Madness, TLC, HGTV, Animal Planet, TNT and many others.
The combined company projects it will produce around $52 billion in revenue and approximately $14 billion in adjusted Ebitda in 2023. It also expects more than $15 billion of DTC (streaming) revenues in 2023 and cost savings of $3 billion. The combined company intends to use free cash flow to reduce leverage from five times at the closing of the deal to three times within 24 months.
AT&T will use the money obtained from the transaction to deleverage immediately and then focus on 5G wireless and optical fibre roll-out, coming full circle and becoming a pure telecom again. The $43 billion obtained from the split will go to net debt reduction at close. It expects the ratio of net debt to adjusted Ebitda to come down to 2.6, ideally reaching below 2.5 by end of 2023.
Conclusion
Overall, I think this transaction will be a net positive for AT&T and will refocus the telecom giant as well as cut its debt, which has become a big concern for investors.
Verizon (VZ, Financial) also recently sold off its media (Yahoo and AOL) to private equity. It is a clear signal that media and pipes are two different business and do not offer synergy. Management needs very different skill sets for the two businesses.
The U.S. market will settle into a telecom oligopoly with Verizon, AT&T and T-Mobile (TMUS, Financial), with a rational pricing structure which should be great for all three. Discovery + Warner is aiming for similar oligopolistic structure in content and will join the top tier with Netflix and Disney. I think investors will be the big winners in this deal, and the recent fall in the stock price of AT&T could also provide an opportunity to pick up shares.
Disclosure: The author owns shares of AT&T and Discovery Inc.
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