A new media giant is born: The AT&T WarnerMedia and Discovery merger

In what may be some of the biggest news this year in stocks - on May 17 AT&T (T) announced that they were spinning off WarnerMedia to merge with Discovery (DISCA) and create a new company. The new company, which is yet to be named will be the world's second-largest media company upon finalization sometime in mid-2020 only behind Disney (DIS).

This is transformational for both of these companies and likely for the streaming space as a whole and as I own a good chunk of AT&T shares in my dividend portfolio I have been following this deal closely. Since opening strong the first few hours on the day of the announcement the share price has taken a beating as uncertainty and doubt have followed the news.

Two things stand out for me as a shareholder of AT&T as negatives: The dividend cut and the loss of HBO Max - The major reason why I was bullish on the stock in the first place. These have both been topics of major discussion and a big reason for the selloff as well - However, I think it is worth investigating what potential upsides there could be of the merger: After all, there must be a reason for this strategic move.

A so-called Reverse Morris Trust transaction. Never heard that one before! Source: AT&T and Discovery Joint Investor Presentation

In essence, WarnerMedia will disconnect from the rest of AT&T and merge with Discovery in its entirety - in the process of constructing a new company, as WarnerMedia is a much bigger asset than Discovery itself. In exchange, AT&T will see $43 billion in debt wiped off its balance sheet and its shareholders will receive stocks representing 71% of the new company. The remaining 29% of the stock will go to Discovery shareholders.

There are a few things I really like here:

1. AT&T will finally shred a significant amount of their debt - Something the company has been struggling to deal with for several years and which has been the single biggest red flag raised for new investors in the stock.

2. New Company will instantly become a behemoth of a media company, commanding one of the largest media libraries in the world. With over 100 years of creating original content, its hours of content will dwarf even the likes of Netflix (NFLX) - and most importantly of all: They will own all their content. Rarely do I get a chance to be part of such an exciting company from day one.

NewCo will own both major traditional TV channels as well as Discovery+ and HBO Max streaming services.

But what also follows the deal is a reduction in dividends. AT&T is a popular stock among dividend investors for paying one of the highest long-term dividends available, currently sitting just below 7%. They are also a Dividend Aristocrat meaning that they have been increasing their dividend for more than 25 years in a row. A title they will now lose as the deal goes through. It is very unusual for a company to let go of this title once they have it as it makes the stock much more attractive to serious dividend investors. It is also the reason I, myself decided to buy into the company in spite of its unattractive balance sheet. The new dividend will be set in the range of 40% to 43% of free cash flow, which is projected to be just above $20 billion - still in the absolute top of dividend-paying companies. What is also important to note and something I think maybe people did not give too much thought to: The current dividend is still in place until the merger goes through, meaning we will see at least two more payouts of the current yield at near 7%.

For this reason, I decided not to sell off. At least not for now. I have chosen a 'wait and see' strategy - in short, I need more information to make my decision. I would love to know how the new company will be branded and how exactly they plan to offer their content to the world. To me, the most interesting constellation would be to combine the two streaming services into one. This, however, is more easily said than done: WarnerMedia consists mainly of high-budget scripted productions like well-known movie franchises and original TV shows whereas Discovery contributes some of the most popular Reality TV and unscripted content available. This creates a media library catering to basically every type of viewer, but also a clash of genres and presents a major branding challenge. One way I could see a way around it would be like what Disney did with their streaming service: A structure where the different content is grouped into their own separate media universes as we see on the home screen of Disney+.

Imagine a structure like this with WarnerMedia franchises like 'DC' and 'Warner Brothers' and Discovery contributing 'Animal Planet' and 'TLC'.

AT&T after the spinoff will still be a huge company, but management will now get to enjoy a much more focused company and business model. The company will be tightly focused on its core as a wireless and broadband provider. While this could lead to good things in the future, it does come at the cost of losing the fastest-growing part of their business. I have been really excited about the subscriber growth of HBO Max over the last couple of months and without it, their potential for growth will be much lower. But I did not buy AT&T expecting major growth - I did it to receive a stable dividend built on a solid business. This will continue to be the case, though at a much lower percentage. The dividend decrease gave me a lot to think about, but ultimately I see an opportunity for AT&T to build a much healthier balance sheet - eventually, this should give an easier justification for letting the share trade at a higher multiple.

Either way, there is still big potential to grow: It will just be under the new company. We should get to see more information surface about the New Company over the next year, while the current dividend yield is still safe. If I like what comes out I gladly keep my shares of AT&T in order to receive ownership of this new construction. If I do not like what comes out, that will give me a reason to sell. Whether or not I will be holding AT&T after the merger will come down to how management executes on improving the balance sheet over the long term. Right now I am hopeful and excited for what is to come.

Disclaimer: I am not a financial advisor, the opinions expressed in this article are entirely my own – always invest at your own risk.