T Stock: Is AT&T Stock a value stock or a value trap?
Investors appear to be taking a “wait-and-see” approach to AT&T (NYSE:J) corporate restructuring. As you probably know, the telecom giant is divesting from its WarnerMedia unit, via a Morris reverse trust transaction with Discovery (NASDAQ:DISCA). Today, shareholders voted to approve the $43 billion merger, and the T stock went nowhere.
After rising 2.2% on the day, T stock fell and ended the day flat. In addition to a broader market reversal, this may have been a case of “buying the rumour, selling the news.”
But the closing of this agreement, which could take place as early as April, and the subsequent sale of the shares of Warner Bros. Discovery (WBD) to AT&T shareholders, are not guaranteed to move the needle for either stock.
For WBD, the market wants to see if the combined company can build a streaming offering that can support netflix (NASDAQ: NFLX) and other streaming leaders. Meanwhile, investors remain skeptical of “Ma Bell’s” turnaround plans and feel burned by the recently announced dividend cut.
That being said, with so much negativity in the price of T shares – the shares are currently 32% below their 52-week high – there is decent upside potential, even if the sell-off is just a partial success.
T Stock could be stuck after the spin-off
The broader market turmoil related to the war between Russia and Ukraine has not weighed too heavily on AT&T shares. Notwithstanding the dividend cut, this is still considered a safe stock. Not to mention that at just 7.7 times forward earnings, it doesn’t get much lower.
While investors may not be overly concerned about further declines in T shares, I can see why they may be concerned about a lack of upside potential.
AT&T as a whole is cheap. The company WarnerMedia is merging into is also cheap, with Discovery trading for 8.8 times forward earnings.
Even so, there is uncertainty as to whether either stock after the sale is repriced positively by the market. While some believe Warner Bros. Discovery is a “Netflix killer” in the making, there are still fears that streaming growth may not replace declines in the combined companies’ respective cable TV streaming businesses.
After downsizing to its legacy businesses, AT&T could wisely cut the dividend to put cash flow to work paying down debt and improving profitability. However, the part of shareholders who invest in T shares only for the dividend are not in favor of this plan. There’s also a lot of skepticism about whether AT&T’s restructuring will pay off, which is understandable given management’s mistakes over the years.
So why buy stocks?
Although the T stock is stuck in neutral and likely to remain so in the short term, I think it is premature to judge this undervalued company a value trap.
Yes, investors aren’t too bullish on legacy media companies looking to become big streaming companies. Just look at the situation with World Paramount (NASDAQ:PARA), Previously ViacomCBS. But the revenue and cost synergies from combining WarnerMedia’s platforms like HBO Max with Discovery’s platforms like Discovery+ could lead the market to recognize the value of Warner Bros. Discovery, which would drive up WBD stock.
In January, BofA analyst Jessica Reif Ehrlich said she expected the merger to succeed, creating “a global media powerhouse”. It gives the WBD share (DISCA share today) a target price of $45 per share. In the best-case scenario, she sees the stock climbing to $57 per share. Since AT&T shareholders will receive 0.24 shares of WBD for each T share they own, this translates to a potential value of $10.80 to $13.68 per share.
AT&T’s core business, despite bailing out dividend investors ahead of the drop, could also see its shares rise. According to figures from Morgan Stanley’s Simon Flannery, the post-spin-off shares of the standalone telecommunications unit will be worth $16.78 and yield 6.6%.
In Flannery’s view, the success of the telecommunications turnaround plan could send T stock back to $20 per share. And even if the turnaround isn’t a resounding success, the stock’s high-yield appeal could help it climb as high as $18.50 per share.
When split into two companies, the combined value of AT&T and Warner Bros. Discovery could rise moderately above where the stock is trading today. Based on the calculations above, this would be an equivalent price ranging from the high $20 to the low $30 per share.
Add to that what will always be a high-yielding dividend payout from the telecommunications unit, and holding T shares could produce much better returns than currently expected. With value trap fears perhaps overblown, consider the T stock a buy at today’s prices.
At the date of publication, Thomas Niel had no position (directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.
InvestorPlace.com contributor Thomas Niel has been writing individual stock analysis for online publications since 2016.