AT & T’s Megadeal is bad news for its dividend but good for its debt

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Investors should be reminded of one important thing: even with rates close to zero, you can have too much debt.

The telecommunications giant announced Monday that it would combine its content business with that of Discovery (ticker: DISCA). This will leave AT&T with a more focused and streamlined business, and a debt burden of $ 43 billion lighter than before. He will also be leaving the company with a lower dividend.

That disappointed investors, with stocks falling about 4.7% to $ 29.90 by mid-morning on the New York Stock Exchange. The stock also fell on Monday, losing 2.7% after a brief jump on the news.

Investors have been questioning the sustainability of AT & T’s dividend for some time, especially after it Significant debt-financed Time Warner takeover in 2018. The fact that he is offloading this business and continuing to cut his dividend may be a bitter pill to swallow for some shareholders, especially those who relied on the regular increases who put him on the list of shareholders.

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AT&T CEO John Stankey defends dividend cuts

The company’s annual dividend payout is now expected to be around $ 8 billion to $ 9 billion, down from $ 15 billion previously.

Notably, a decent amount of this $ 43 billion debt reduction could come from the new company’s debt: Goldman Sachs and JPMorgan Chase have pledged to provide a bridge loan of up to $ 41.5 billion to the combined company. , according to a regulatory file. This loan can be used on a cash payment or a special dividend to help fund the transaction, which will be structured as a Reverse Morris Trust for tax purposes. And the remaining $ 1.5 billion could just be the new company, called WarnerMedia, that is taking Time Warner’s debt out of AT&T’s hands.

Regardless of its form or where it comes from, that $ 43 billion in compensation matters to AT&T bondholders because the telecommunications giant had a lot of debt, especially for a premium company. Moody’s said Monday AT&T was “weakly positioned” for its rating two levels above junk before the deal. And in March, S&P Global Ratings warned of the risk of downgrading, attributing AT&T a “negative” outlook due to potential costs estimated at $ 27 billion for this year’s 5G spectrum offering. S&P also rates the company at two levels above junk. And while the AT&T spin-off of DirecTV will be give him extra cash to pay off the debt, almost $ 8 billion was not expected to make a big dent.

At the end of the first quarter, AT & T’s approximately $ 169 billion net debt left it with net leverage of 3.1 times adjusted earnings before interest, taxes, depreciation and amortization, according to CreditSights. The company says the


The deal will reduce its net leverage to 2.6x Adjusted EBITDA after it closes, and it plans to further reduce debt after that, “through a combination of growing EBITDA and paying down debt. “, said Pascal Desroches, CFO of AT & T, during the call to investors.

Bondholders applauded the news. AT&T bonds were among the most traded on MarketAxess on Monday, according to the trading platform. And the company’s bonds maturing in July 2045 and March 2042 saw their yield spreads against T-bills narrow significantly, placing them among the top performers on the ICE BofA US Corporate Index, which tracks bonds. top quality business.

The deal is a “win-win-win” for AT & T’s credit, CreditSights analyst Davis Hebert wrote in a Monday night note. He highlighted the benefits of reducing the $ 43 billion debt and eliminating the “volatile” media sector. He also estimated that the company will spend $ 2-3 billion less on interest each year after debt reduction.

The apparent prioritization of debt reduction is particularly notable because borrowing costs are still very low for quality companies. The Federal Reserve has kept rates near zero for over a year now, after cutting them near those levels to ease financial conditions during the pandemic.

But no matter how easy those financial terms may be, AT&T still felt the pinch, “due to the negative effects of the pandemic on many of the company’s operations as well as the costs associated with launching HBOMAX,” Moody’s wrote. in his Monday Note.

Normally, companies only need to make tough decisions between shareholder payments, interest payments and other expenses like staff when interest rates rise. The high debt burden and low cash flow have therefore not been a major concern for investors.

But AT&T is a prime example of why investors may want to be cautious with heavily leveraged dividends, regardless of the rate outlook.

Of course, the company does not really shudder its shareholders. To arrive at the figure of $ 8 billion to $ 9 billion, executives estimated that the company will reach $ 20 billion in annual free cash flow after the creation of the new company WarnerMedia. That number intrigued CreditSights’ Hebert, who thinks it is too high.

“We see this as a big win for credit, but we can’t reconcile that $ 20 billion free cash flow figure,” he said. This implies that shareholders can get a bigger slice of the cash flow pie than the company would like bondholders to think.

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