The Long and Short
AT&T debt should compress closer to Verizon
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AT&T moved one step closer to merging its WarnerMedia business with Discovery Inc. (DISCA) as the required waiting period to complete the combination has expired without action by regulators. While the combination with DISCA creates one of the largest media companies globally, it sets the stage for T to reduce debt and hit its leverage target ahead of previous expectations. The overall debt reduction should serve as a catalyst for T spreads to collapse closer to those of Verizon (VZ: Baa1/BBB+/A-).
Exhibit 1. T Curve vs. VZ Curve (1Y-30Y)
Source: Bloomberg TRACE; APS
The deal is expected to close in the second quarter this year and provide T with roughly $40 billion of proceeds to reduce debt. Given T’s continued focus on debt reduction and explicit comments on reaching its 2.5x net leverage target by the end of 2023, T could get most of its debt reduction completed by repaying debt maturities in 2022 and 2023, including the repayment of terms loans. T’s leverage has the potential to fall below VZ’s. The most value sits in the back end of T’s curve as the trading differential is 20 bp to 30bp wide to VZ.
T’s Leverage Could Fall Below VZ’s
While VZ maintains a net leverage target in the 1.75x-2.0x range, management has noted that they don’t expect to achieve that goal until 2025-2026. VZ ended fiscal 2021 with net leverage of 2.8x, which was in line with guidance provided at the company’s Investor Day. VZ expects to use free cash flow after dividends to continue to reduce debt. Network investments may limit its ability to repay debt as capital expenditures continue to rise. Furthermore, the dividend consumes roughly $10.5 billion annually. VZ also has minimal debt maturing through 2023 ($2.5 billion), which means it would need to execute tenders or make-wholes to reduce debt meaningfully in order to reduce leverage.
Should the WarnerMedia deal be consummated on time, we would expect T management to get underway in reducing net debt relatively quickly. We note that approximately $1.6 billion of Time Warner debt that was not exchanged will travel with the WarnerMedia separation. Additionally, roughly $13 billion of AT&T debt will be exchanged into new WarnerMedia debt. That leaves cash of roughly $23.4 billion-$24.4 billion, after working capital adjustments which Discovery noted on its recent earnings call was currently estimated to be in the $4.0 billion-$5.0 billion range, for further debt reduction.
Maturity Profile Supports Reduction of Over $20 billion of Debt by FYE23
We note that through 2023, T has approximately $23 billion of debt maturities which includes two of its three existing term loans, as seen in Exhibit 2. That means that T could execute more than 90% its expected debt reduction from the cash from the transaction through maturities alone. This would alleviate the company’s need to execute a large tender offer requiring them to pay early tender premiums and/or premiums above par. While we still expect T to look to execute tender offers, T may look to target higher coupon debt or look to attack maturity walls to limit refinancing risk, particularly as rates are expected to rise this year. We also believe the size of the tender will depend on which existing T debt is part of the $13 billion exchange.
Exhibit 2. T Debt Maturity Schedule (2022-2028)
Source: Bloomberg; APS
T’s current weighted average maturity is just under 15 years (14.89 years) with a weighted average coupon of 3.72%. T’s weighted average maturity is just over two years longer than VZ, but its weighted average coupon is roughly 50bps higher than VZ’s, as seen in Exhibit 3. While T has targeted its higher coupon debt in previous tender offers, we note that T maintains some coupons above 4% that are maturing between 2024 through 2028. Those bonds could be targeted in a tender offer as it could help to smooth some maturity walls in 2024, 2026 and 2027 while limiting refinancing risk, particularly as rates are expected to rise, with APS’ Chief Economist calling for seven quarter-point rate hikes this year alone.
Exhibit 3. T vs. VZ Debt Statistics
Source: Bloomberg; APS
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