Is DirecTV Ready to Soar as It Heads Into its Buyout by AT&T?

Source: Wikimedia Commons

After AT&T announced on May 18 that it would be acquiring DirecTV in a transaction valued at $48.5 billion (or $95 per share), the shares of the company and its acquiree dropped. Now, with DirecTV's stock having more than 12% upside on a deal that both company's boards have approved, why haven't its shares rallied and is there any chance that investors could get in on a near-guaranteed gain?


AT&T and DirecTV's combination will create a telecom giant!
Right now, AT&T is one of the largest providers of broadband in the United States. With 11 million U-verse high-speed Internet connections and an additional 5.5 million DSL and other broadband connections, the company ranks as a force to be reckoned with. In an attempt to grow even more, AT&T arrived at the conclusion that purchasing DirecTV would make sense, especially at a time when the industry is undergoing a period of consolidation.

Following its acquisition of DirecTV, AT&T can grow its high-speed broadband connection count from 11 million customer locations to 15 million while extending out its total network to 70 million customer locations. This, combined with the estimated $1.6 billion in cost synergies that are expected to develop by the third year after the merger, could make for a meaningful rise in value for the combined company and its shareholders.

Source: Wikimedia Commons

Using each company's most recent fiscal data, AT&T would see its revenue climb from $128.8 billion to $160.5 billion following its purchase of DirecTV. Meanwhile, the business's net income would rise from $18.2 billion to $21.1 billion and free cash flow would hit $16.5 billion, slightly higher than the $13.9 billion management reported last year. Factoring in rising sales over time and the $1.6 billion in savings that management expects, this acquisition may yield significant value potential.

What does this mean for investors who want to get in now?
Assuming that AT&T's math is right, it looks like its purchase of DirecTV is sensible. However, what does this mean for the Foolish investor who wants in on the action now? If the deal is not blocked by regulators and goes through as planned, it looks like shareholders could get the equivalent of $95 per share. However, the composition of the acquisition could actually result in DirecTV's investors getting less of a deal than expected.

You see, AT&T has announced that it will be giving DirecTV's shareholders $28.50 in cash per share with the remaining $66.50 being given in the form of AT&T stock. While the cash component of the deal is set in stone, the amount of shares granted to DirecTV's shareholders could change based on the value of AT&T's shares when the companies complete the deal.

In order to protect itself from share-price fluctuations, AT&T set a collar on its stock. What this means is that, no matter what price its shares trade for at the time of closing, it has locked in a minimum and maximum conversion ratio at which it will exchange its shares for DirecTV's shares.

Source: Created by Author with Data from AT&T

In the event that AT&T's stock is trading at a price of $38.58 or higher at the time the deal closes, DirecTV's shareholders will receive just 1.724 shares of AT&T stock for each share of their stock (plus the cash component). In the event that AT&T's stock is trading at $34.90 or lower this ratio will rise to 1.905, while something in the middle would be calculated using AT&T's initial $66.50 share-equivalent offer divided by the company's current stock price.

To illustrate this, if Mr. Market believes that AT&T will see tremendous value growth over time and its stock price hits, say, $42.00, then the value that DirecTV's investors would receive would equal $100.91 per share, 6% above the initial offer. On the other hand, the fact that AT&T is using stock for a large portion of its deal could leave investors doubting the company's share value and this could, in turn, push both its stock price and the deal's price tag down. If this ends up happening and AT&T's stock price drops to, say, $30.00, then DirecTV's investors would get just $85.65 apiece, barely making a profit from the transaction.

Final takeaway
Based on the data provided, it's not too hard to see the benefits that could accrue to AT&T through its purchase of DirecTV. In addition to increasing revenue and profitability, the deal could set up the business to grab hold of a larger customer base and increase its competitiveness. However, for investors hoping to grab a quick, "guaranteed" buck, it's not advised to hold your breath. Because of the collar placed on the deal, there's no promise of any kind of return, let alone a big payday.

Rather, investors should be more focused on whether or not the marriage between AT&T and DirecTV will create long-term value. If you believe that it will, buying DirecTV shares could be a nice way to play AT&T. In addition to the potential for a nice bump up in the share price, investors who grab onto DirecTV's stock will be given AT&T's stock after the deal closes. This will likely grant the Foolish investor an attractive opportunity to see strong gains down the road if management can decrease the company's costs and grow sales because of its larger market presence. 

Your cable company is scared, but you can get rich
In an effort to save themselves, companies like AT&T and DirecTV are undergoing major consolidations. However, there are other companies out there vying for a spot in your living room that could make you a ton of dough!

You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple. 

 

The article Is DirecTV Ready to Soar as It Heads Into its Buyout by AT&T? originally appeared on Fool.com.

Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends DirecTV. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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