AT&T (T 1.10%) closed its spin-off of Warner Bros. Discovery (WBD 1.08%) on April 8, and the two stocks started trading separately on April 11. AT&T's investors received a 0.24 share of Warner Bros. Discovery for each share of AT&T they owned, and they now collectively own 71% of Warner Bros. Discovery's shares on a fully diluted basis.
AT&T and Warner Bros. Discovery both claim they will generate better returns as separate companies, but is either stock worth buying right now? Let's review their plans for the future to find out.
Image source: AT&T.
AT&T goes back to the basics
Prior to the spin-off, AT&T's stock price had declined about 40% over the past five years. It struggled to digest its debt-fueled acquisitions of DirecTV and Time Warner, it ceded pay-TV customers to streaming services like Netflix, and it was squeezed by Verizon and T-Mobile in the wireless market.
AT&T eventually realized that it bit off more than it could chew, so it spun off DirecTV last year, divested a lot of its non-core assets and real estate, and gave up on Time Warner less than three years after it closed the deal. Those moves all streamlined its business, reduced its leverage, and enabled it to focus on improving its core wireless and broadband businesses instead.
AT&T estimates that on a pro forma basis (which normalizes the year-over-year comparisons to account for its divestments and spin-offs) it will grow its revenue by the low single digits in 2022. It expects its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to rise 2%-4%, and for its adjusted earnings per share (EPS) to grow 0%-2%.
In 2023 it expects its revenue to rise by the low single digits, its adjusted EBITDA to grow 5%-7%, and for its adjusted EPS to increase 2%-7%. It plans to boost its annual capex from $20.1 billion in 2021 to about $24 billion in both 2022 and 2023 to upgrade its broadband and 5G networks. Even as it expands, AT&T expects to reduce its net-debt-to-adjusted-EBITDA ratio from 3.1 at the beginning of 2021 to 2.5 by the end of 2023.
That stable outlook makes AT&T more comparable to Verizon, which is also expected to generate low-single-digit revenue and earnings growth for the next two years. AT&T also reduced its annual dividend from $2.08 to $1.11 per share after its spin-off, but its forward yield of 5.7% remains much higher than Verizon's forward yield of 4.7%.
Warner Bros. Discovery gears up for growth
Warner Bros. Discovery expects to grow at a much faster clip than AT&T. HBO Max and Discovery+ already had 74 million and 22 million streaming subscribers at the end of 2021, respectively, so the combined company likely has a streaming audience of nearly 100 million subscribers.
That still makes it much smaller than Netflix, which ended 2021 with 221.8 million subscribers, as well as Disney, which reported 196.4 million streaming subscribers across all of its services in the first quarter of 2022. But it's still far ahead of Paramount Global, which ended last year with 56 million subscribers across Paramount Plus and Showtime.
Warner Bros. Discovery's CEO David Zaslav hasn't offered any exact subscriber forecasts for its streaming services yet, but he claims they could eventually reach "200, 300, 400 million" viewers over the long term. That's an ambitious goal, but the company has plenty of content and believes it has room for growth in both the ad-free and ad-supported markets.
Based on the two companies' combined forecasts for 2022, Warner Bros. Discovery will likely generate $49.8 billion in revenue and $10.4 billion in adjusted EBITDA in 2022. In 2023, it expects its revenue to grow about 4% to $52 billion -- with $15 billion coming from its direct-to-consumer (DTC) business -- and for its adjusted EBITDA to rise 35% to $14 billion.
It expects to generate $3 billion in annual cost savings from the merger and to reduce its net-debt-to-adjusted-EBITDA ratio from 4.5 to "3x or below" within the next two years. It also expects to generate $8 billion in free cash flow in 2023, but it will likely reserve most of its cash for the development of future content instead of spending it on big buybacks or dividends.
The valuations and verdict
AT&T and Warner Bros. Discovery both look fundamentally undervalued. AT&T's enterprise value is just eight times higher than its adjusted EBITDA estimate for 2023, while Warner Bros. Discovery's enterprise value is roughly seven times its adjusted EBITDA target for the same year.
As an AT&T investor, I currently own both of these stocks. But if I had to keep one over the other, I'd sell AT&T and keep Warner Bros. Discovery because it has more growth potential. It will face a lot of competition from Netflix, Disney, Paramount, and other media companies, but it can also resort to more aggressive tactics without being shackled to AT&T's sluggish telecom business.
