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AT&T’s Upcoming Discovery Deal Is Its Only Appeal

AT&T (NYSE:T) stock has been a major disappointment for shareholders. T stock is down not just year-to-date, but also over the past 12 months. Additionally, it has lost roughly 25% of its value compared to where it traded prior to Covid-19. All this occurred in the midst of the huge market-wide bull run.

Image of AT&T (T stock) logo on a gray storefront.Image of AT&T (T stock) logo on a gray storefront.

Source: Jonathan Weiss/Shutterstock

AT&T’s problems stem from a long-running issue: its lack of growth. AT&T’s core telephone business is a cash cow, but it has limited growth prospects. To overcome that, management engaged in an increasingly ambitious set of acquisitions to try to jumpstart the enterprise.

But some of these planned buys, such as DirecTV and WarnerMedia, failed to meet expectations. In the end, AT&T ended up with a massive debt load and insufficient cash flow to meet its large dividend and interest burden.

A Dividend Cut and Strategic Repositioning

To address AT&T’s structural problems, management has shifted its focus. Now, it is pruning off the non-core businesses. It is divesting its media business by merging it with Discovery (NASDAQ:DISCA) and then spinning that firm off.

The company believes the combined assets might have enough critical mass to compete with Netflix (NASDAQ:NFLX) and Disney (NYSE:DIS). In any case, it should do better under dedicated management than it does being run by AT&T’s executives.

Meanwhile, AT&T is unloading other things as well. The DirecTV business was recently spun off to a private equity owner, for example. In making these moves, AT&T can reduce its debt and refocus the firm on its more successful core telecom operations.

Alas, one thing didn’t survive the reshuffling. AT&T’s dividend yield, which was up more than 7%, will face a nearly 50% cut once these asset divestments are complete. With a much smaller business and revenue base to work with, it makes sense that AT&T will have to scale back its dividend as well.

Don’t Worry About the Discovery Deal Pessimists

The biggest moving piece for AT&T right now is its upcoming deal with Discovery. There has been some speculation that AT&T will change the terms of the deal. This, in turn, could be a negative for T stock. Why is this being discussed?

Many investors are under the impression that DISCA stock is cheap right now. It did crash from $78 this spring to its current price around $28. That’s a huge pullback.

However, keep in mind that Discovery only ran up because Bill Hwang’s Archegos Capital ran shares up. Hwang bought stocks like Discovery on massive leverage.

When Hwang ran out of margin borrowing capacity, however, his stocks collapsed. One former Archegos pick, Gaotu Techedu (NYSE:GOTU), fell even harder than DISCA stock — it has lost more than 90% of its value since the short squeeze ended.

Many Hwang stocks have settled back around where they traded prior to the pandemic. So it goes for Discovery. DISCA stock traded between $20 and $30 for most of the past five years. Thus, a $28 stock price now is hardly surprising — it has simply settled in its traditional trading ground.

All this to say there’s no need for AT&T to recast the Discovery deal. DISCA shareholders are complaining about the stock’s low price now, and that makes sense if they’re still anchored on its artificial valuation from the short squeeze. But at the end of the day, there’s no reason for AT&T to change the game plan for its media merger.

T Stock Is Not a Buy Outside the Discovery Deal

The upcoming deal with Discovery is by far the most interesting piece of the AT&T story. It’s understandable that some investors might want to hold on to T stock until the spin-off is complete. Shares of the new media entity might pop once it is a free-trading stock on its own.

But if that’s not their thesis, investors should steer clear of T stock. It got into this mess due to management’s poor capital allocation decisions. Simply put, AT&T likes to make big acquisitions, and these have failed with an alarming consistency.

Once the Discovery deal is done, AT&T will need to get back to basics. It needs to prove it can still operate its telecom business well while paying down debt and getting the company back on firmer footing.

This process will take a while to play out, however. And the slashed dividend will keep income investors from returning to T stock for quite while. Verizon (NYSE:VZ) stock is a much cleaner and simpler way to own stable blue chip U.S. telecom shares.

On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.