AT&T Analyst Downgrade Pits Time Warner Against Dividend Concerns

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It has been known for decades that price wars are great for consumers and horrible for companies involved. That is particularly true for the companies that dominated for years. It turns out that the four-way wireless price war is no exception to the rule when it comes to the wide world of telecom.

Merrill Lynch had been a holdout bull for AT&T Inc. (NYSE: T) for some time. That ended on July 13, 2017, and the call isn’t just about a price war. Analyst David Barden and his telecom team downgraded AT&T to Neutral from Buy, slashing the price target to $39 from $46. The team also removed AT&T from the firm’s prized US 1 list of top Buy-rated stocks.

While much of the outside concern has been around the price wars, the impetus for this downgrade was actually ahead of the $40 billion stock issuance that will be used to acquire Time Warner Inc. (NYSE: TWX). In short, about 20% new shares will be issued.

This has brought up issues for the dividend, but there are also some fuzzy issues brought up about real merger synergies. AT&T has assumed that it can reduce Time Warner’s operating costs by 5%, about $1 billion, over three years. Merrill Lynch gives this a net present value of synergies at about $8.7 billion, using a 10% discount rate.

The team said:

Our rating change is based on lower positive catalyst visibility (corporate tax reform) and potential technical headwinds to emerge related to the Time Warner merger. We see few reasons the deal would fail to close as expected. Reports peg the deal closing as soon as September while AT&T remains confident of a close in the second half. The overhang of $40 billion in new equity issuance associated with the closing of the Time Warner acquisition and further tightening of the deal spread will increasingly weigh on AT&T’s stock making outperformance challenging absent some other catalyst, in our view.

Merrill Lynch did note that there are some positive issues out there. The firm also warned that those are external to AT&T for the time being. The expectation for corporate tax reform was the most promising and positive potential catalyst, but the market has been ratcheting down those expectations.

One potential benefit would be further industry consolidation in wireless, specifically noting the ongoing speculation of Sprint Corp. (NYSE: S) and T-Mobile US Inc. (NASDAQ: TMUS). This would lead to a less intense competitive environment. Merrill Lynch further noted that voice, video and broadband metrics are likely to have been seasonally challenged in the second quarter, with AT&T likely having lost share in each category. That video category will be a blow, considering that AT&T spent so much (about $67 billion) to acquire DirecTV.

Merrill Lynch sees subscriber metrics as a loss of 1,000 broadband subscribers, down from a gain of 115,000 last quarter. Video subscriber declines moved from a loss of 170,000 down to a loss of 335,000; and wireless is also expected to lose on a post-paid basis.