AT&T (T) and Discovery (DISCA) join forces to create a formidable player in the streaming space

AT&T Inc. (NYSE: T) entered into an agreement to spin off its WarnerMedia business and combine it with Discovery Inc. (NASDAQ: DISCA) to create a new media company. The transaction is expected to help the companies create a strong player in the streaming space and it will also allow AT&T to focus on its core wireless business.

Deal summary

As per the terms, AT&T will receive $43 billion in a combination of cash, debt securities, and WarnerMedia’s retention of certain debt. AT&T’s shareholders will own 71% of the new company while Discovery shareholders will own 29%. The deal is expected to close in mid-2022.

The deal will bring together two leading content creators, each with strong libraries of movies and television content. It will bring the likes of HBO, Warner Bros., DC Comics, CNN, Cartoon Network, TNT and Animal Planet among others, under one umbrella. Discovery’s President and CEO David Zaslav will lead the new company.

The new company is projected to generate revenue of approx. $52 billion, adjusted EBITDA of approx. $14 billion and free cash flow conversion rate of approx. 60% by 2023. It is also expected to yield at least $3 billion in expected cost synergies annually for the new company.

Streaming services

The AT&T-Discovery alliance is anticipated to create a formidable player in the streaming space capable of competing with Netflix (NASDAQ: NFLX) and Walt Disney’s (NYSE: DIS) Disney+. The total number of HBO and HBO Max global subscribers were 64 million at the end of the first quarter of 2021. Last month, Discovery said the total number of its DTC subscribers had reached 15 million. The new company is targeting DTC revenues of over $15 billion in 2023.

Netflix ended its most recent quarter with 208 million paid memberships, which was below its guidance of 210 million. Disney had 103.6 million paid subscribers at the end of its second quarter of 2021, which was also below what analysts had expected. This slower-than-expected growth can be attributed to the massive spike seen during the COVID-19 pandemic and the subsequent normalization.

AT&T post transaction

Following the close of the merger, AT&T expects its remaining assets to generate annual revenue growth at a low single digits CAGR from 2022 to 2024. Annual adjusted EBITDA and adjusted EPS are expected to grow at a mid-single digits CAGR during the same period.

AT&T expects annual capital expenditures of around $24 billion post the closure of the transaction. The company also expects an annual dividend payout ratio of 40-43% on anticipated free cash flow of more than $20 billion.

Shares of AT&T and Discovery were down over 2% and over 4%, respectively, in afternoon trade on Monday.

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