AT&T To Spin-Merge WarnerMedia With Discovery

Northbrook – Circa June 2019: AT&T central office. AT&T wrapped up its merger with WarnerMedia and … [+] now controls HBO, CNN and DirecTV


Deal Overview

On December 28, 2021, AT&T Inc.

(NYSE: T, $25.64, Market Capitalization: $183.1 billion) announced that the company had received a favorable ruling from the IRS, signaling the deal to combine WarnerMedia with Discovery

would be tax-free for shareholders.
Previously on May 17, 2021, AT&T Inc. and Discovery, Inc. (NASDA

: DISCK, $25.94, Market Capitalization: $17.7 billion) had announced a definitive agreement to combine WarnerMedia’s premium entertainment, sports, and news assets with Discovery’s leading nonfiction and international entertainment and sports businesses to create a premier, standalone global entertainment company. The new publicly traded company (Merged Entity) would be named Warner Bros. Discovery. Post spin-off and merger transaction, AT&T (RemainCo) will operate the company’s existing Communications

segment and Latin America segment. The Communications segment offers wireless voice, data communications services, broadband, including fiber, legacy telephony internet and voice communication, and wireline telecom services. Latin America segment provides video entertainment and audio programming services under the DIRECTV and SKY brands primarily to residential customers; pay-TV services, including HD sports video content, and postpaid and prepaid wireless services.

AT&T Price Performance

Spin-Off Research

The transaction will be executed through a Reverse Morris Trust, under which WarnerMedia will be spun-off /split-off to AT&T’s shareholders via dividend or through an exchange offer or a combination of both and simultaneously combined with Discovery. AT&T’s shareholders would receive stock representing 71% of the newly merged company; Discovery shareholders would own 29% of the new company. The transaction would be tax-free to AT&T and AT&T’s shareholders (except to the extent that cash is paid to stockholders of the company instead of fractional shares in the Distribution or the Merger). The transaction is anticipated to close in mid-2022, subject to regulatory approval in the US. In connection with the spin-off , AT&T will receive $43 billion (subject to adjustment) in a combination of cash, debt securities, and WarnerMedia’s retention of certain debt. NewCo expects to maintain an investment-grade rating and utilize the significant cash flow of the combined company to rapidly de-lever to approximately 3.0x within 24 months and target a new, longer term gross leverage target of 2.5x-3.0x. WarnerMedia has secured fully committed financing from JPMorgan Chase Bank

, NA, and Goldman Sachs & Co

. LLC affiliates to fund the distribution. Discovery President and CEO David Zaslav will lead Warner Bros. Discovery (Merged NewCo) along with a management team from both companies. The NewCo’s Board of Directors will consist of 13 members, 7 initially appointed by AT&T, including the chairperson of the board; Discovery will initially appoint 6 members, including CEO David Zaslav. LionTree LLC and Goldman Sachs & Co. LLC served as financial advisors, and Sullivan & Cromwell LLP served as legal advisor to AT&T. Allen & Company LLC, and J.P. Morgan Securities LLC served as financial advisors, and Debevoise & Plimpton LLP served as legal advisor to Discovery. Peralla Weinberg Partners and Wachtell Lipton, Rosen & Katz served as advisors to the Independent Directors of Discovery.

Spin-Off Details and Top 5 Shareholders

Spin-Off Research

Deal Rationale

In 2018, AT&T acquired WarnerMedia (previously TimeWarner) when it saw subscription on-demand video streaming (SVOD) as a profitable opportunity. The company observed that the bulk of customers’ monthly data was used to stream videos with the emergence of smartphones and mobile internet. By acquiring WarnerMedia and leveraging its content along with the HBO distribution channel as a cross-selling feature, AT&T planned to attract and retain wireless subscriptions, while also capitalizing on upsides from the surge in demand for SVOD streaming services. Although the strategy has been proven somewhat successful with more than 25% of HBO / HBO Max subscribers also having a connectivity service contract in place with AT&T, it came with a cost as AT&T became the world’s most indebted non-financial company as a result of the ~$85 billion transaction at the time, straining its balance sheet. Meanwhile, the company’s competitors like Verizon and T-Mobile had achieved similar results in retaining wireless subscription loyalty through joint promotional offers with Disney+ and Netflix

in recent years without having to pay billions. Instead, they have been able to deploy similar capital towards building their respective 5G capabilities to capitalize on the surge in demand for higher speed services.

The spin-off of WarnerMedia and merger with Discovery will allow AT&T (RemainCo) to focus on communications business (including wireless mobility and broadband) and maintain market share within the increasingly competitive communications sector. Moreover, the transaction will also help reduce its net debt by ~$43 billion and provide the flexibility required for funding the build-out of its 5G wireless network, and its fiber broadband footprint. For AT&T and its shareholders, the transaction provides an opportunity to unlock value in its media assets and better position the media business to take advantage of the attractive DTC trends in the industry. The separation will result in two independent companies, one broadband connectivity company, and the other media company, to sharpen the investment focus and attract the best investor base for each company. It would allow each company to tailor its capital structure and capital allocation decisions to its specific business model. The transaction is likely to create substantial value for AT&T and Discovery shareholders by bringing together the strongest leadership teams, content creators, and high quality series and film libraries in the media business. It will accelerate both companies’ plans for leading direct-to-consumer (DTC) streaming services for global consumers and unite complementary and diverse content strengths with broad appeal – WarnerMedia’s robust studios and portfolio of iconic scripted entertainment, animation, news, and sports with Discovery’s global leadership in unscripted and international entertainment and sports. NewCo is expected to have significant scale and investment resources with projected 2023 revenue of ~$52 billion, adjusted EBITDA of ~$14 billion, and an industry-leading Free Cash Flow conversion rate of ~60%. It will create ~ $3 billion in expected cost synergies annually for the new company to increase its content and digital innovation investment and scale.

AT&T has continued to press forward with its transformation program in recent years, which primarily entails the shift in focus back to its roots in core communications, including wireless mobility and broadband. Accordingly, the strategy has led to the sell-off of non-core businesses to support an aggressive deleveraging strategy, freeing up resources and capital necessary to support the build-out of AT&T’s 5G and fiber broadband eff orts. In addition to the transfer of DirecTV to a joint venture structure with private equity firm TPG, AT&T has also disposed of its ownership interests in Playdemic (mobile games app studio) and Otter Media (over-the-top media platforms including Crunchyroll anime business). Together, the transactions have generated ~$9.1 billion in net cash inflows. Continued monetization of non-core assets has also brought AT&T to the halfway mark of its $6 billion long-term cost savings program set out last year. Moreover, AT&T has also recently announced that it has entered into agreements to sell Vrio (live and on-demand video service platform in Latin America) and Xandr (digital advertising business). Following the completion of the transaction, AT&T is expected to achieve free cash flows of more than $20 billion and intends to distribute dividends at a payout ratio of 40% – 43%. While the post spinoff dividend payout structure is a discount to AT&T’s current dividend payout ratio of 55% on ~$28 billion of free cash flows, the company is expected to deliver attractive growth in the years thereafter as it continues to gain market share in 5G and broadband, which will accordingly drive attractive long-term dividend payouts.

Key Data

Spin-Off Research

Company Description

AT&T Inc. (Parent)

Headquartered in Dallas, Texas, AT&T Inc (NYSE: T) was incorporated in 1983, providing telecommunication, media, and technology services worldwide. The company operates through Communications, WarnerMedia, and Latin America segments. The Communications segment offers wireless voice and data communications services; video and targeted advertising services; broadband, including fiber and legacy telephony internet and voice communication; and wireline telecom services. This segment markets its communications services and products under the AT&T, Cricket, AT&T PREPAIDSM, AT&T TV, AT&T Fiber, and DIRECTV brand names. The WarnerMedia segment primarily produces, distributes, and licenses television programming and feature films. It also operates cable networks, video-on demand streaming platforms under the HBO Max and HBO GO names; multichannel pay television services under HBO and Cinemax. The Latin America segment offers video entertainment and audio programming services under the DIRECTV and SKY brands primarily to residential customers; pay-TV services, including HD sports video content; and postpaid and prepaid wireless services under the AT&T and Unefon brands, as well as sells various handsets through company owned stores, agents, and third-party retail stores. The company recorded sales of $171.8 billion in FY20.

WarnerMedia (Spin-Off )

The WarnerMedia segment primarily produces, distributes, and licenses television programming and feature films; distributes home entertainment products in physical and digital formats, and produces and distributes mobile and console games and consumer products, and offers brand licensing services, and advertising services. It also operates cable networks, video-on-demand streaming platforms under the HBO Max and HBO GO names; multichannel pay television services under HBO and Cinemax; and digital media properties and licenses its content to television networks over-the-top services. Recently it sold all of the Otter Media assets in the 3Q21. The segment recorded sales of $30.4 billion in FY20.

Warner Bros. Discovery (Merged Entity)

The spun-off WarnerMedia will be merged with Discovery Inc to form Warner Bros. Discovery (Merged Entity). AT&T’s shareholders would receive stock representing 71% of the merged entity, while Discovery shareholders would own 29%. At present, Discovery Inc (NASDAQ: DISCK) is a media company that provides content across various distribution platforms in approximately 50 languages worldwide. The company operates in two segments, US Networks and International Networks. The Warner Bros. Discovery (Merged NewCo), a pure-play content company, will own one of the deepest libraries in the world with nearly 200,000 hours of iconic programming and will bring together over 100 of the most cherished, popular, and trusted brands in the world under one global portfolio, including HBO, Warner Bros., Discovery, DC Comics, CNN, Cartoon Network, HGTV, Food Network, the Turner Networks, TNT, TBS, Eurosport, Magnolia, TLC, Animal Planet, ID and many more. SpinCo will compete globally in the fast-growing direct-to-consumer business, bringing compelling content to DTC subscribers across its portfolio, including HBO Max and the recently launched discovery+. The transaction will combine WarnerMedia’s storied content library of popular and valuable IP with Discovery’s global footprint, a trove of local language content, and deep regional expertise across more than 200 countries and territories. The company is expected to have significant scale and investment resources with projected 2023 Revenue of ~$52 billion, adjusted EBITDA of ~$14 billion, and an industry-leading Free Cash Flow conversion rate of ~60%.

Organization Structure

Spin-Off Research