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.

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