AT&T & Warner Bros. Discovery: Market rewards shareholders

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Despite a few tough years for investors in the entertainment and telecommunications conglomerate AT&T (NYSE: T), the market finally seems to think that the worst for the company is over. I say this because I follow the final spin-off and merger of WarnerMedia with Discovery to create Warner Bros. Discovery (NASDAQ: WBD), shares in both companies rose nicely. Shares in AT&T, adjusted for spinoff, rose 7.7% in just one day. And shares in WarnerMedia rose 1.4 percent. This enthusiasm may well wane in the short term. However, when assessing the basic condition of both entities, it is clear that the value still exists for long-term investors. This is not to say that the value proposition is the same for both companies. Clearly, the biggest opportunity seems to be with those who focus on AT&T. But now that we have a better understanding of how Warner Bros. Discovery will look like, and how the market received the new independent entertainment company, it seems that there may also be an upside there.

AT&T stock is still drastically undervalued

As I wrote in a previous article, AT&T still seems to be a significantly undervalued company after its spinoff of WarnerMedia. Based on some analyzes I performed after the publication of the company’s financial results for 2021, I have come to the conclusion that equities offer a huge upside for long-term investors. Based on the currently available data, adjusted for the compensation the company received from its spinoff, it should have a net debt of about $ 114.83 billion. The company has an additional $ 5.13 billion in preferred shares and its market value at the time of writing is $ 140.22 billion. Together, this gives us a business value for the company of $ 260.18 billion.

AT&T expected finances

Author – SEC EDGAR Data

As management mentioned earlier, the company should generate EBITDA of around $ 41.5 billion for the fiscal year 2022. This should increase to $ 44 billion by 2023. Meanwhile, the cash flow from operations should be around $ 40 billion this year and it should increase up to 44 billion next year. With these numbers, the shares in the conglomerate appear to be quite cheap. Even after experiencing some upside after the end of the spin-off, the company is trading at a price to the operating cash flow multiple, using its 2022 estimates of just 3.5. This drops to 3.2 if we rely on estimates for 2023. Meanwhile, the EV to EBITDA multiple for the company should be around 6.3 for 2022, with that figure falling to 5.9 next year.

AT&T stock trading multiples

Author – SEC EDGAR Data

Perhaps the best company to compare AT&T with right now would be Verizon Communications (VZ). At present, Verizon is trading at an operating liquidity multiple price of 5.7. This figure is actually expected to rise to 5.8 on a forward-looking basis. Meanwhile, the company’s EV for EBITDA multiple appears to be 8.9. The forward reading for this is 8.1. To put this in perspective, by using the 2022 forecasts for AT&T and comparing them with the more conservative multiples for Verizon, we would have an implied upside for AT&T shareholders of between 54.2% and 62.6%.

Warner Bros. Discovery is not bad either

While I’m convinced that AT&T is where the true opportunity lies, I’ve become more optimistic about Warner Bros. Discovery. First, the shares in the company do not look so expensive. In pre-spin and merger documents, it was calculated that the pro forma revenue for Warner Bros. Discovery would be $ 45.53 billion. Although the company would generate a net loss of $ 3.01 billion, its EBITDA would be $ 10.85 billion. Using EBITDA minus interest expense as a proxy for operating cash flow, this metric would be around $ 8.26 billion on a pro forma, normalized basis.

At present, the company’s net debt should be around $ 46.68 billion, while its current market value is $ 59.45 billion. This implies a company value of $ 106.13 billion for the company. Using the aforementioned estimates, Warner Bros. trades. Discovery at an operational cash flow multiple price of 7.2 and an EV to EBITDA multiple of 9.8. It is a bit challenging to compare it with other companies in this field. For example, we only need to look at two companies to illustrate how difficult a relative valuation is. One of these examples would be Netflix (NFLX). This pure streamer has done well for itself over the last many years. That said, cash flows from operations are inconsistent. However, what will be a little easier to look at is EBITDA. Based on my calculations, that figure was $ 18.63 billion last year. This implies an EV to EBITDA multiple of the company of 8.8. Another player who has done extremely well in the streaming field has been that The Walt Disney Company (HAZE). But it operates as a diversified entertainment company with amusement parks and other assets not related to streaming. It is also still recovering from the COVID-19 pandemic, so cash flows and EBITDA are not exactly what I would call normalized at this time. Still, the price of the company’s operating liquidity multiple should be 47, while the EV to EBITDA multiple is 32.9.

Ignoring the relative valuation, as a general rule of thumb, the current multiples that Warner Bros. Discovery deals to, are considered attractive. On top of this, while I do not expect the company’s HBO and HBO Max streaming operations to be near as attractive as Disney and Netflix have, there is a clear path towards further value creation. Back in the last quarter of fiscal year 2020, HBO and HBO Max had 60.6 million global subscribers, of which 41.5 million were in the domestic market. By the end of 2021, these figures had grown to 73.8 million and 46.8 million, respectively. Before the assets were separated, AT&T predicted that they would have between 120 million and 150 million subscribers to the platform by the end of 2025. This was higher than a previously expected range of between 75 million and 90 million. Deutsche Bank, meanwhile, estimates that the service could have as many as 194 million by the end of 2026.

HBO Max subscribers


It is also important to note that Discovery seemed to be doing well even before the merger with WarnerMedia. Between 2017 and 2021, the company grew its revenue from $ 6.87 billion to $ 12.19 billion. This happened despite revenue falling from $ 11.14 billion in 2019 to $ 10.67 billion in 2020. The company went from generating a net loss of $ 337 million in 2017 to generating a profit of $ 1.01 billion last year. Although it is worth noting that 2021 marked the third year in a row in which profits fell. Operating liquidity grew over the past five years from $ 1.63 billion to $ 2.80 billion, while this figure, excluding changes in working capital, grew from $ 3.52 billion to $ 6.04 billion. But again, the company has not fully recovered from the pandemic, and 2019 marked the high year for both of these measurements. For better or worse, investors in Warner Bros. Discovery predicts the same management that drove some of these actions to remain in control of the company now. Andy Forssell, head of HBO Max, and Ann Sarnoff, WarnerMedia’s head of studio / network operations, have both left the combined company. This largely leaves Discovery staff in charge of the business.

Take away

As an opening salute to a new day, investors should be pleased with the performance achieved by AT&T and Warner Bros. Discovery. However, future volatility will almost certainly occur just like for any other business. That said, I think the value still exists with both of these companies. Although investors may be tempted by the growth prospects of Warner Bros. Discovery, I think the strongest value proposition still exists at AT&T. That’s why I intend to sell my shares in Warner Bros. Discovery and buy additional shares in AT&T.

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