Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Get ready for a tug of war over AT&T's Inc. cash because once the Time Warner Inc. megadeal closes that money will need to stretch further than it ever has before. 

Indebted to Deals
After the Time Warner acquisition, AT&T will look like a very different company
Source: Bloomberg
Note: Figures are for latest period, but leverage ratio upon deal completion should be similar.

AT&T is in the process of wrapping up its $109 billion acquisition of the TV-network and movie-studio owner, a bet that bundling Time Warner's content with AT&T's distribution will create a must-have service to keep customers from switching. Bloomberg News reported Monday that U.S. antitrust officials have progressed to talks with the companies about potential closing conditions, which suggests the government lawyers have nearly finished their review. And on Tuesday's second-quarter earnings call, AT&T management reiterated that it expects to be done with the transaction by year-end.

I've written about the merits of the wireless-entertainment corporate mashup (here) as well as the challenges facing AT&T (here) as it grapples with cord-cutting in its DirecTV division and a price war with wireless service rivals. But one topic that's been given less attention is the balance sheet. AT&T has assured its stakeholders of "rapid deleveraging potential." However, there is some skepticism in the debt community that reducing leverage is quite so high on AT&T's list of post-deal priorities. 

No Lift
Even with two mega-deals -- DirecTV and now Time Warner -- AT&T shares continue to trail rivals'. It may turn to buybacks, which leaves less cash for paying down deal debt.
Source: Bloomberg

Initially, its net debt will spike to around $182 billion, slightly more than triple the combined company's Ebitda, according to Bloomberg calculations. That's a big leap from a ratio of less than 2.4 currently and a mere 1.5 at the end of 2014, just before AT&T bought DirecTV for $67 billion. The company is transforming into a more leveraged conglomerate, which will take some getting used to. It's not the same ole AT&T, which is probably more of a good thing than not. But it could also turn off some investors that owned AT&T stock or debt for its predictability. 

Unfazed, For Now
Yields on AT&T bonds are declining alongside other corporates even as the wireless carrier nears completion of a mega-merger that will stretch its balance sheet
Source: Bloomberg

Before the acquisition spree  AT&T had been repurchasing a lot of stock. Should its shares continue to underperform and trade at what management might consider cheap levels, it will probably buy back more. As a telecom company, AT&T also pays a fat dividend -- 70 percent of free cash flow last year, or about $11.8 billion. That's all to be expected.

Returning Cash
Through dividends and share buybacks, AT&T has returned a lot of money to shareholders over the years
Source: Bloomberg

More important, though, remember that AT&T is in a race to introduce a 5G wireless network. It will be pitched as a faster connection for customers wanting to binge on video streaming, such as watching HBO shows that AT&T will soon own thanks to the Time Warner deal. Building out this network is crucial to the company's growth strategy around video entertainment, and it will be very expensive and eat up a lot of cash. But this, no doubt, needs to be AT&T's top priority.

So if that's No. 1, shareholder returns have to be second, and reducing leverage could be more of a "when we get to it" matter. GimmeCredit LLC's Dave Novosel, one of the credit analysts I spoke with in recent weeks, said similar:

"My sense is that they're willing to live with much higher leverage than they had before."

To be sure, management has said otherwise. Back when the transaction was announced, CFO John Stephens predicted net debt-to-Ebitda will be in the 2.5 times range by the end of the first year after the deal gets done and will approach 1.8 by the end of the fourth year. He said the same at a conference the following month, pointing to the growth in Ebitda the company will have and $1 billion in potential synergies by the end of year three. Time Warner had been buying back stock, so those funds could be redirected for paying down debt, too. 

Even so, AT&T needs everything to go right when it comes to this megamerger. The balance sheet may have to live in the shadows of 5G for a while.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Recall AT&T also tried to buy spectrum owner Straight Path Communications Inc. but lost to Verizon Communications Inc. in what became a very expensive bidding war. 

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net