AT&T (NYSE:T) is planning on spinning off its WarnerMedia division in a merger with Discovery, Inc. (NASDAQ:DISCA, NASDAQ:DISCB, NASDAQ:DISCK) very soon. The new company will be called Warner Brothers Discovery with the ticker WBD. T stock is starting to reflect this spinoff, as well as the proposed dividend cut.
I wrote about this at the end of February and described how the spinoff will work mathematically. Investors in AT&T will keep their shares and will also receive 24 shares in WBD for every 100 shares of T stock they own.
However, based on the Jan. 26 announcement by AT&T, the dividend will be cut to $1.11 annually, down from $2.08, a drop of 46.63%. However, investors should be careful when they assess what the new dividend yield will be.
Here is how that will work.
Calculating the Post-Close Dividend Yield
As of Mar. 10, AT&T stock traded for $23.19. But that does not mean that the new dividend yield will be $1.11 / $23.19, or 4.79%. This is because T stock has to fall by an amount that equals the value of the spinoff of WarnerMedia and the creation of the new company WBD.
In my last article, I showed the math of how that valuation might end up. I calculated that the value of the spinoff could be about $6.59. This reflects a 20 times earnings before interest, taxes, depreciation, and amortization (EBITDA) number for WBD, based on our estimates. That could change, though, as we get more information from AT&T and Discovery.
The market will automatically reduce the value of T stock reflecting the exit of real, cash flow-producing assets out of AT&T. If my calculations are correct, the AT&T stock price will fall by $6.59 to $16.60. Therefore, the new, post-close dividend yield is $1.11 / $16.60, or 6.69%.
Another Way to Calculate the Dividend Yield
Here is another simple way to calculate how much AT&T stock could fall. Right now Discovery has a market value of $12.37 billion, according to Yahoo! Finance. And according to Seeking Alpha, its market value is similar.
Now, since we know that Discovery shareholders will own 29% of the combined company WBD, we can assume that WBD as an implied value of $12.68b / 0.29, or $57.5 billion. Since AT&T shareholders will own 71% of that company, the implied value to them of the spinoff is $57.5b to $12.68b, or $41.82 billion. And since there are 7.143 billion AT&T shares outstanding, that works out to $5.85 per AT&T share.
Therefore, we subtract $5.85 from the recent price of $23.19 to get the new post-spinoff price of T stock: $17.34. As a result, the new dividend yield will be 6.4% (i.e., $1.11 / $17.34).
This shows that AT&T stock will still have a very high dividend yield, even after the spinoff of WBD shares. Moreover, we still do not know yet whether Warner Brothers Discovery plans on paying a dividend or not. I consider that unlikely since Discovery has not been paying a dividend.
What to do With T Stock
This spinoff will be a tax-free transaction. However, investors still need to calculate their tax basis in both T stock and WBD stock. They should be aware that if they sell their WBD shares, they will have to allocate a portion of their original investment cost in AT&T stock to the WBD shares.
Typically, the spinoff company will provide information for investors to be able to calculate this basis. It will be in the FAQ section of the investor relations portion of the website after the closing of the spinoff.
However, I do not think that investors should prematurely sell off their WBD shares just because the new T stock will have a high yield. The thinking is that they would then buy more shares in AT&T in order to get the same level of dividend payments. The problem is that you will have to pay a capital gains tax on the sale of the WBD shares based on the appropriate tax allocation of both shares.
Therefore, if you have a large number of AT&T shares, you should consult with your tax advisor to figure out the best approach to take. It might actually make more sense to buy WBD shares, as they are likely to fall when investors sell them off.
Either way, expect that the new dividend yield for AT&T will be between 6.4% and 6.69%, a very high level.
On the date of publication, Mark Hake did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.