Stocks to buy

Is AT&T Stock a Value Stock or a Value Trap?

Investors appear to be taking a “wait and see” approach to AT&T’s (NYSE:T) corporate restructuring. As you likely know, the telecom giant is spinning off its WarnerMedia unit, via a reverse Morris trust transaction with Discovery (NASDAQ:DISCA). Today, shareholders voted to approve the $43 billion merger, and T stock went exactly nowhere.

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After being up as much as 2.2% on the day, T stock turned lower and finished the day flat. In addition to a reversal in the broader market, perhaps this was a case of “buy the rumor, sell the news.”

But the closing of this deal, which could happen as soon as April, and the subsequent spinning off of Warner Bros. Discovery (WBD) stock to AT&T shareholders, isn’t guaranteed to move the needle for either stock.

For WBD, the market wants to see if the combined company can build a streaming offering that can take on Netflix (NASDAQ: NFLX) and the other streaming leaders. Meanwhile, investors remain skeptical of “Ma Bell’s” turnaround plans and are feeling burned by the recently announced dividend cut.

That being said, with so much negativity priced into T stock — shares currently sit 32% below their 52-week high — there’s a decent amount of upside potential, even if the divestiture is only a partial success.

T Stock Could Remain Stuck After the Spinoff

Broader market turmoil related to the Russia Ukraine war hasn’t taken too much of a toll on AT&T shares. Dividend cut notwithstanding, this is still regarded as a safe harbor stock. Not to mention that at just 7.7 times forward earnings, there’s not much lower it can go.

While investors may not be too concerned about further downside in T stock, I can see why they may be concerned about a lack of potential upside.

AT&T as a whole is cheap. The company it’s merging WarnerMedia into is cheap as well, with Discovery trading for 8.8 times forward earnings.

Even so, there’s uncertainty over whether either stock post-divestiture gets positively re-rated by the market. While some think Warner Bros. Discovery is a “Netflix killer” in the making, there’s still concern that growth from streaming will fail to replace declines in the combined companies’ respective cable television broadcasting businesses.

After slimming down to just its legacy business, AT&T may be wisely cutting the dividend in order to put cash flow to work paying down debt and improving its profitability. However, the portion of shareholders who invest in T stock solely for the dividend aren’t keen on this plan. There’s also plenty of skepticism about whether AT&T’s restructuring will pay off, which is understandable given management’s blunders over the years.

So Why Buy Shares?

While T stock is stuck in neutral, and likely to stay that way in the short term, I think it’s premature to deem this undervalued company a value trap.

Yes, investors aren’t overly bullish on legacy media companies looking to become major streaming companies. Just look at the situation with Paramount Global (NASDAQ:PARA), formerly ViacomCBS. But the revenue and cost synergies from combining WarnerMedia’s platforms like HBO Max with Discovery’s platforms like Discovery+ could result in the market recognizing the value of Warner Bros. Discovery, in turn sending WBD stock higher.

In January, BofA analyst Jessica Reif Ehrlich said she expects the merger to be successful, creating “a global media powerhouse.” She gives WBD stock (DISCA stock today) a price target of $45 per share. In the best-case scenario, she sees shares moving up to $57 per share. Given AT&T shareholders will receive 0.24 shares of WBD for each share of T stock they own, that translates into $10.80 to $13.68 per share in potential value.

The core AT&T business, despite dividend investors bailing out ahead of the cut, could see its shares rise as well. Per numbers from Morgan Stanley’s Simon Flannery, post-spinoff shares of the standalone telecom unit will be worth $16.78 and for a yield of 6.6%.

In Flannery’s view, success with the telecom turnaround plan could send T stock back to $20 per share. And even if the turnaround is not a resounding success, the appeal of the stock’s high yield could help it inch up to $18.50 per share.

The Bottom Line on T Stock

Once broken up into two companies, the combined value of AT&T and Warner Bros. Discovery could move up moderately above where the stock trades today. Based on the calculations above, that would be an equivalent price ranging from the high $20s to low $30s per share.

Add in what will still be a high-yielding dividend payout from the telecom unit, and holding T stock could produce far better returns than currently expected. With value trap fears possibly overblown, consider T stock a buy at today’s prices.

On the date of publication, Thomas Niel did not have (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.

Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.

Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.