Discovery, AT&T Pressured As Wall Street Digests Media Megadeal

Shares of Discovery (DISCA) and AT&T (T) are under a second day of pressure on Tuesday after the companies yesterday announced a definitive agreement to combine WarnerMedia's entertainment, sports and news assets with Discovery's nonfiction and international entertainment and sports businesses to create a standalone global entertainment company. While Citi analyst Jason Bazinet upgraded Discovery to Buy following the news, his peer at Wells Fargo acknowledged that the "transformative deal" brings some near-term overhangs given its complexity. Meanwhile, Amazon (AMZN) is reportedly in talks to acquire MGM, with Morgan Stanley analyst saying that such a deal would be the "biggest signal yet" of the e-commerce giant's streaming media focus.

MEDIA DEAL: On Monday, AT&T and Discovery announced a definitive agreement to combine WarnerMedia's entertainment, sports and news assets with Discovery's businesses to create a standalone global entertainment company. Under the terms of the agreement, which is structured as an all-stock, Reverse Morris Trust transaction, AT&T would receive $43B in a combination of cash, debt securities, and WarnerMedia's retention of certain debt, and AT&T's shareholders would receive stock representing 71% of the new company; Discovery shareholders would own 29% of the new company. The boards of both AT&T and Discovery have approved the transaction. The new company is projected for 2023 revenue of approximately $52M, adjusted EBITDA of approximately $14B, and free cash flow conversion rate of approximately 60%. The transaction is expected to create at least $3B in expected cost synergies annually for the new company.

MEDIA TRANSACTION MAKES SENSE: Following the news, Citi analyst Jason Bazinet upgraded Discovery to Buy from Neutral with a price target of $44, up from $40. The analyst believes the media transaction makes sense for both AT&T and Discovery. Discovery needs additional scale in terms of content and advertising spending to compete effectively in a direct-to-consumer world, and AT&T "potentially brings sufficient scale on both dimensions," Bazinet told investors in a research note. The analyst also believes other bidders for Discovery are possible. Discovery's platform and content can fit very well with emerging ad-based video on demand streaming strategies, and Comcast (CMCSA), ViacomCBS (VIAC) and Disney (DIS) could all be interested, Bazinet added.

DEAL COMES WITH OVERHANG: While Wells Fargo analyst Steven Cahall believes this was "the right deal" for Discovery, WarnerMedia and AT&T to build better strategic enterprises, Cahall acknowledged that in its complexity it brings some near-term overhangs for Discovery. Nonetheless, the analyst is "incrementally" bullish on the long-term. "This feels a lot like the opportunity" when Discovery closed its deal for Scripps Networks, Cahall contended. He has an Overweight rating and a price target of $46 on Discovery shares.

AT&T LIKELY TO CUT DIVIDEND BY 45%: KeyBanc analyst Brandon Nispel told investors in a research note on Tuesday that following the review of the investor presentation and Discovery and AT&T's joint conference call, he believes the latter is likely to cut its dividend by 45%, despite basically telling investors, "We don't believe it's priced into the stock." Towers likely stand to benefit from AT&T accelerating C-Band deployment, and Cable appears no worse off than before with AT&T's new fiber targets, the analyst contends. Initial pro forma estimates make the new company appear highly levered and expensive, Nispel added.

OTHERS TO WATCH: Benchmark analyst Matthew Harrigan said he believes that Monday's 5.5% selloff in shares of Comcast was "excessive" even though Discovery and WarnerMedia's planned merger does increase pressure on Peacock's advertising-based video on demand execution and poses "special European challenges for Sky." Harrigan pointed out that the new Discovery-WarnerMedia's "melding of scripted shows, international and U.S. sports, and news closely mirrors Peacock's programming approach." He reiterated a Buy rating and a $70 price target on Comcast shares.

Also commenting on the news, Evercore ISI analyst Vijay Jayant said he believes the planned transaction makes strategic sense for both AT&T and Discovery and views the transaction as "slightly accretive" to AT&T shareholders. Jayant argued that the market is likely to view such a transaction as a negative for both ViacomCBS and Fox (FOXA) given reduced M&A optionality for the broadcast TV network owners, as "modestly negative" for Disney and Netflix (NFLX) due to increased competition and as a "perceived negative" for broadband and wireless competitors given that AT&T expects to become more aggressive in building fiber and C-band spectrum following the deal.

AMAZON IN TALKS TO BUY MGM: Amazon is "weeks" into discussions on a potential agreement to acquire Metro-Goldwyn-Mayer for roughly $9B, Variety's Todd Spangler, Joe Otterson, and Cynthia Littleton reported, citing industry sources. Amazon's interest in buying the film studio has taken on a new tenor beyond the typical rumor mill, as a deal is being orchestrated by Amazon TV boss Mike Hopkins directly with MGM board chairman Kevin Ulrich, whose Anchorage Capital is a large MGM investor, the authors noted, citing sources.

MGM has been for looking for a buyer for months, with $9B floated as an asking price, The New York Times' Brooks Barnes wrote, adding that Apple (AAPL) and Comcast had previously kicked MGM's tires and decided it was worth roughly $6B. It was unclear how much Amazon might be willing to spend, according to the people briefed on the talks.

Following press reports indicating that Amazon is in talks to buy MGM Holdings for about $9B, Morgan Stanley analyst Brian Nowak noted that such a deal, if confirmed, would be the company's largest acquisition outside of Whole Foods Markets and would send "the biggest signal yet" of the company's growing focus and investment in streaming video. If Amazon were to acquire MGM's studio, this could arm it to compete more directly with larger studios like Warner Bros., Disney, Paramount, 20th Century Fox and Netflix, but Amazon would also likely have to invest more to produce new content from the MGM library of franchises, the analyst said. Nowak has an Overweight rating and $4,500 price target on Amazon shares.

PRICE ACTION: In Tuesday morning trading, shares of AT&T have dropped about 5% to $29.91, while Discovery has slid fractionally to $33.70. Both stocks were initially higher on Monday morning before giving up those early gains and closing with losses on Monday.

Disclaimer: TheFly's news is intended for informational purposes only and does not claim to be actionable for investment decisions. Read more at  more

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