Last month I wrote about the upcoming spinoff at AT&T (NYSE:T). It has not announced how much the exact dividend cut (“nearly 50%“) will be and the deal is still a year off. Since then, T stock has fallen about 3% from $29.55 to $28.65 as of last week’s close. But it still does not make sense to buy T stock, as I suspect the stock will fall further.
This is despite the fact that clearly, AT&T shareholders will gain in the transaction. Despite the dividend cut, they will receive shares spun off into a new company. This company is still unnamed, but it will be the result of a combination of both Discovery (NASDAQ:DISCA, NASDAQ:DISCB, NASDAQ:DISCK) plus the media assets of AT&T (i.e., what AT&T is calling a “Spinco.”). The Spinco will consist of both Time Warner (i.e., HBO, etc.) and DirectTV.
The Dividend Cut Conundrum
Did you follow all that? To make matters even confusing, no one knows yet how many exact shares will be spun off per AT&T share. But we know two things that should be negative influences on AT&T stock. First, it will likely fall further thanks to the 50% cut in the dividend. Second, the spinoff of the unnamed combination of Discovery and the Spinco (Time Warner and DirectTV), will automatically set AT&T stock lower again, by the amount of the per-share value of the spin0ff this time.
But, on the plus side, the value of the spinoff shares will likely make up for a good portion of the lower price for AT&T now. This is especially since analysts expect there will likely be a dividend paid from the spinoff shares.
But here is the conundrum. AT&T now is very cheap with a 7.2% dividend yield (i.e., $2.08/$28.65), But the dividend won’t be cut for at least three quarters from now. And even then, shareholders will get shares in the spinoff media combination company.
Shareholders are playing it safe. They suspect that the new lower dividend of $1.04, or maybe $1.10 (i.e., nearly 50% off $2.04), will have a yield of 4% to 5%. Therefore let’s calculate the expected target price. If we divide $1.10 by 4%, we get a target value of $27.50. But if we use a 5%, i.e., divide $1.10 by 0.05, we get a target price of just $22.
In other words, T stock, at the previously mentioned $28.65, could fall another $1.15 to $27.50, the expected price if it has a 4% dividend yield. It could also fall another $6.65 to $22 or a drop of 23.2% from here.
And, of course, the negative effect would be worse if the dividend is cut exactly 50% to $1.04.
What To Do With T Stock
The conundrum is that we know that there will be a value from the spinoff company. And that value could partially or wholly make up for this drop. But since AT&T has not yet said what those values are, we don’t know how much this will hedge the expected T stock drop.
Moreover, most AT&T shareholders are probably not sophisticated enough to care about the spinoff. They are likely to just sell the shares, even though the spinoff will be non-taxable and a sale would be a taxable event.
So, I suspect, as a result, there will be added pressure on T stock from here. It could easily fall to $22, or even further. For example, let’s say that after all is said and done a year from now the stock ends up with a 6% dividend yield. That is the equivalent of a price today of $18.33 (i.e., $1.10/0.06), or a drop of 36% from today. This is despite the added spinoff shares in the account.
Therefore, be careful with T stock. Even though it is clearly a bargain today, in a weird way, it probably better, if you are not risk-averse, to either short T stock or buy a put option.
Be careful to close out the position before the spinoff ex-date is set. However, you could also average cost into T stock. Either way, expect fireworks, mostly on the downside, with AT&T stock.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.