Demand for wireless and TV services has slowed at both AT&T and Verizon. To spur long-term earnings, the two are buying firms that complement their main businesses. These acquisitions add risk, but we feel they will ultimately pay off with more cash for dividends.
AT&T INC. $36 (New York symbol T; Conservative Growth and Income Portfolios, Utilities sector; Shares outstanding: 6.2 billion; Market cap: $223.2 billion; Price-to-sales ratio: 1.4; Dividend yield: 5.4%; TSINetwork Rating: Average; www.att.com) will buy media company Time Warner Inc. (New York symbol TWX) for $85.4 billion in cash and shares. If you include Time Warner’s debt, the total value of the deal is $108.7 billion.
Time Warner owns several popular cable TV channels, including CNN, HBO, TNT, TBS and Cartoon Network. Its Warner Bros. studio also produces TV shows and movies.
Following the purchase, Time Warner investors will own roughly 15% of the combined company.
The deal gives AT&T access to a wide library of popular video content. That programming should help attract the growing number of subscribers who want to stream video on their smartphones and other wireless devices.
The company expects the new operations will add to its earnings in the first year. Eliminating overlapping costs should also cut the combined company’s annual expenses by $1 billion in the third year.
Time Warner shareholders must approve the purchase. As well, the deal faces high regulatory hurdles as AT&T could potentially withhold certain content from other TV and wireless carriers. Even so, the company is confident that it can complete the transaction by the end of 2017.
Meantime, AT&T’s revenue in the three months ended September 30, 2016, rose 4.6%, to $40.9 billion from $39.1 billion a year earlier. The gain is largely due to its July 2015 purchase of DirecTV for $48.5 billion (70% stock and 30% cash). This business now has 20.8 million satellite TV customers in the U.S., and 12.5 million in Latin America.
The company added 1.3 million wireless subscribers (net of cancellations) in the U.S. It now has a total of 133.3 million subscribers in that country. It also has 10.7 million wireless customers in Mexico.
Due to the DirecTV purchase, earnings in the quarter rose 11.2%, to $3.3 billion from $3.0 billion. Earnings per share gained 8.0%, to $0.54 from $0.50, on more shares outstanding. If you disregard costs to integrate DirecTV, the company earned $0.74 a share, unchanged from a year ago.
AT&T is also raising its quarterly dividend by 2.1% with the February 2017 payment, to $0.49 a share from $0.48. The new annual rate of $1.96 yields 5.4%. The company has now increased the payout each year for the past 33 years.
Big acquisitions like Time Warner almost always come with hidden problems that can hurt the expected benefits. But we feel the purchase will ultimately spur AT&T’s long-term growth. That will also give it more room to keep increasing its dividend.
AT&T is a buy.
VERIZON COMMUNICATIONS INC. $48 (New York symbol VZ, Conservative Growth and Income Portfolios, Utilities sector; Shares outstanding: 4.1 billion; Market cap: $196.8 billion; Price-to-sales ratio: 1.5; Dividend yield: 4.8%; TSINetwork Rating: Average; www.verizon.com) has 113.7 million wireless users, 14.2 million landline phone clients and 15.6 million high-speed Internet and TV subscribers.
The company is buying the Internet search business and related websites of Yahoo! Inc. (Nasdaq symbol YHOO). These operations attract over 1 billion active users every month.
The purchase looks like a good fit with AOL, which Verizon acquired in 2015 for $4.4 billion. That business operates several popular websites, including The Huffington Post, TechCrunch and Engadget.
Adding Yahoo should help Verizon with its plan to offer more video content to its TV and mobile phone subscribers. It will also let the company capture a larger share of the fast-growing online advertising market.
Verizon originally agreed to pay $4.8 billion for Yahoo. But it will probably demand a lower price after Yahoo disclosed that online intruders stole the private data of 500 million users. That could have a significant impact on Yahoo’s brand and ad revenues. The company still expects to complete the purchase in the first quarter of 2017.
Meanwhile, Verizon earned $3.6 billion, or $0.89 a share, in the three months ended September 30, 2016. That’s down 10.1% from $4.0 billion, or $0.99 a share, a year earlier. However, if you disregard unusual items, such as charges related to employee pensions, Verizon earned $1.01 a share in the latest quarter.
Overall revenue in the quarter fell 6.7%, to $30.9 billion from $33.2 billion.
Revenue from the wireless business (75% of the total) declined 3.9%. That’s because more of its customers are choosing plans with lower monthly fees. These agreements separate out the cost of the phone and often leave the telephone service as the only recurring bill. Customers usually pay upfront for their devices.
Revenue from the wireline operations (25% of revenue) fell 2.3%. Lower demand from business clients offset stronger sales of high-speed Internet and TV services to consumers.
Verizon will likely earn $3.99 a share for all of 2016, and the stock trades at a moderate 12.0 times that forecast.
The company also recently raised its quarterly dividend by 2.2%, to $0.5775 a share from $0.565. The new annual rate of $2.31 yields 4.8%. Verizon has now increased its dividend each year for the past 10 years.
In the past year, dividends accounted for 78.8% of Verizon’s free cash flow (cash flow less capital expenditures).
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