Tags: Gandel | AT&T | DirecTV | cash flow

Fortune's Gandel: AT&T's Deal to Buy DirecTV Doesn't Add Up

By    |   Tuesday, 20 May 2014 10:33 AM

AT&T struck a deal to buy DirecTV for $95 per share, but the stock is trading much lower than that. How can that possibly be? According to Fortune Senior Editor Stephen Gandel, it's because investors don't want to end up owning AT&T stock when the companies merge.

Shares of DirecTV were below $85 on Monday, down nearly $1.50 on the first day of trading after the weekend announcement of the mega-deal.

"This is, of course, odd, but perhaps not as peculiar as it seems," Gandel wrote.

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"Shares of acquisition targets often trade for less than their proposed purchase prices. There's the risk that the deal won't get done. Plus, you don't get your money immediately."

But the gap between the $95 purchase price and DirecTV's current trading price is still outsized, especially since there are Wall Street experts that specialize in merger arbitrage, that is buying shares of acquired companies to close the gap between trading price and acquisition price.

At a post-announcement news conference, AT&T CEO Randall Stephenson focused on how well the combined companies would be able to deliver video wirelessly directly into the home.

"At the same time, a good portion of what's driving this deal seems to be financial. AT&T is not a company that's full of growth potential. So, to attract shareholders, it has promised a big dividend," Gandel noted.

The trouble with that scenario, however, is that AT&T's free cash flow, from which it pays dividends, is getting smaller. AT&T had $19 billion in free cash flow two years ago, but that figure had shrunk to $11 billion before the DirecTV deal.

Even factoring in the addition of DirecTV's free cash flow and operational savings from the merger, the pie is still shrinking, according to Gandel.

On top of that, AT&T is paying for DirecTV partly in stock. At the current price, DirecTV investors will receive about 935 million AT&T shares, the equivalent of $65 for each one of their DirecTV shares. The rest of the purchase is in cash and possibly some debt, which could force AT&T's annual dividend obligation up to $11.4 billion.

"Put it all together, and the DirecTV deal, at least financially, doesn't seem like that much of an improvement for AT&T," Gandel argued. He cited estimates the DirecTV deal could eat up 81 percent or more of AT&T cash flow.

"DirecTV's stock is trading at a discount to the deal price not because investors think they won't end up getting AT&T's shares but rather because they don't want them," he quipped.

Barron's take on the AT&T-DirecTV deal comes to a different conclusion. It said buyers of DirecTV stock now are getting a discount on AT&T shares, presuming the deal ultimately goes through.

According to Barron's, there are at least two reasons for the wide spread. "There is some concern that antitrust regulators could block the deal, although the view on the Street now is that the deal has a strong chance of approval."

In addition, Barron's noted, "Arbs [arbitragers] buying DirecTV and shorting AT&T to capture the spread have to pay AT&T's big 5 percent dividend while getting nothing from DirecTV, which pays no dividend."

For Forbes' Jeff Bercovici, the bottom line on the AT&T-DirecTV deal is that it means that telecommunications and television are now essentially the same business.

Editor’s Note: Retire 10 Years Earlier With These 4 Stocks

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AT&T struck a deal to buy DirecTV for $95 per share, but the stock is trading much lower than that. How can that possibly be? According to Fortune Senior Editor Stephen Gandel, it's because investors don't want to end up owning AT&T stock when the companies merge.
Gandel, AT&T, DirecTV, cash flow
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2014-33-20
Tuesday, 20 May 2014 10:33 AM
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