AT&T (T, Financial) completed the acquisition of DirecTV in July of 2015 for $63 billion. The company recently announced an even larger acquisition.
AT&T now plans to acquire Time Warner (TWX, Financial) for $106.4 billion. AT&T is going ‘all in’ on media.
The idea is to create a vertically integrated content creation and distribution company. The combination makes sense. AT&T can collect user data to more accurately determine which content to produce.
This will increase advertising revenue. The combination of both advertising revenue and subscription revenue from the company’s other service offerings will create more earnings stability.
The acquisition dwarfs recent media acquisitions made by AT&T’s rival, Verizon (VZ, Financial). Verizon’s recent media related acquisitions are shown below:
- $4.8 billion for Yahoo
- $4.4 billion for AOL
- Undisclosed amount for Complex (a pop culture site)
Verizon has spent under $10 billion on acquiring media companies. Verizon is focusing on online businesses.
AT&T’s recently announced acquisition is more than 10x as large as Verizon’s recent media purchases. AT&T is focusing on television and movie (video) content.
A quote from AT&T’s Time Warner Analyst Call Presentation sheds light onto the company’s thinking about media:
“Premium content always wins – on the big screen, the TV screen, and now on the mobile screen.”
AT&T’s recently announced acquisition will catapult the company ahead of Verizon in the telecommunications arms race for content.
The image below shows the brands/stations AT&T will acquire with the Time Warner Acquisition.
Source: AT&T’s Time Warner Analyst Call Presentation, slide 6
Will this be good for shareholders?
There’s no question this acquisition will make AT&T larger, but will it be beneficial for shareholders?
The bigger a company gets, the more pay its CEO can command (on average). Creating value for shareholders is not always the same as making the company larger. AT&T is financing $42.7 billion of the acquisition with new shares.
Diluting current shareholders.
The company currently has 6.1 billion shares outstanding. After the acquisition the company will have 7.2 billion shares outstanding. Every dollar invested in AT&T becomes 85 cents due to the share issuance.
That’s what shareholders lose. But they gain Time Warner.
Time Warner has seen its adjusted earnings per share grow every single year since it spun off Time Warner Cable and AOL in 2009. The company is expecting around $4.4 billion in profit in fiscal 2016.
For comparison, AT&T is expecting (before the acquisition) around $17.5 billion in profit. Discounting both synergies and acquisition costs, here’s how the acquisition works out for AT&T shareholders:
- Expected 2016 earnings per share without acquisition: $2.85
- Expected 2016 earnings per share with acquisition: $2.82
This does include an additional $1.6 billion in expected interest charges from the ~$40 billion in new debt AT&T will issue to fund the transaction.
The company expects potential synergies in the range of $1 billion a year.
If these synergies are achieved, here’s how it would impact AT&T’s earnings per share:
- Expected 2016 earnings per share without acquisition: $2.85
- Expected 2016 earnings per share with acquisition & synergies: $2.96
Will the acquisition be good for shareholders? Yes. It will be accretive to earnings, though it does increase AT&T’s risk by adding another $40 billion in debt (in addition to Time Warner’s debt) to the company’s balance sheet.
If AT&T’s management can find a way to wring any synergies out of the deal (and they will), then the deal will be accretive to earnings per share. AT&T management expects the deal to be accretive to earnings per share within the first 12 months.
The deal will be good for shareholders, but it will be better for management. It certainly builds the company’s empire.
What if AT&T had decided to take on $40 billion in debt and simply repurchase shares instead?
Note: I’m not saying this is wise, it’s just for comparative purposes.
The company could have reduced its share count from around 6.1 to around 5.1 billion shares outstanding. This would have increased earnings per share (including added interest expense) from $2.85 to $3.11 per share.
Final thoughts
AT&T is a high quality business. It has increased its dividend payments for 33 consecutive years. This makes AT&T one of only 50 Dividend Aristocrats.
I expect the company to continue growing at a mid-single digit rate and to reward shareholders with increasing dividends.
The acquisition of Time Warner does make strategic sense. But it appears to be more rewarding for the company’s management than it does for shareholders. Verizon’s strategy of spending ‘only’ $10 billion (or a little less) on content creators appears more prudent – and less dilutive to shareholders.
AT&T is betting big. The company will continue to get bigger. But not all of that value will trickle down to shareholders due to share dilution.
This isn’t to say AT&T is a bad investment. The market has not responded favorably to the acquisition announcement. Shares are down from around $39.50 before the announcement to around $37.00 at the time of writing this article.
AT&T is trading for a dividend yield of 5.1% and a forward price-to-earnings ratio of just 12.5. The company ranks well using The 8 Rules of Dividend Investing.
The Time Warner acquisition will not destroy shareholder value, but it is questionable whether it is the best use of funds. Still, you cannot speak too badly about a company’s management when they maintain an 80% payout ratio and have increased dividends for 33 consecutive years.
Disclosure: I am not long any of the stocks mentioned in this article.
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