AT&T's Bid Flunks Verizon Dividend Test

Updated from 10:00 a.m ET with Berkshire Hathaway comment and additional information throughout

NEW YORK (TheStreet) - AT&T (T), after announcing a merger with pay TV provider DIRECTV (DTV), is now moving in a different direction than Verizon (VZ), its primary competitor in the U.S. wireless market. AT&T's dividend growth rate is the metric to judge whether the company has found the right deal in DIRECTV.

>> Read More: How to Read an AT&T and DIRECTV Merger

For now, Verizon's dividend growth is more obvious than AT&T's and some analysts and investors may also conclude its long-term strategy is also better wrought.

When Verizon acquired Vodafone's (VOD) 45% interest in Verizon Wireless for $130 billion last September, the company also told shareholders it would raise its quarterly dividend 3%. AT&T, however, is making no pronouncements about its dividend in the company's attempt to buy DIRECTV for $48.5 billion in cash and stock, or $67 billion when factoring in debt assumed in the transaction.

Verizon and AT&T's dividend may be the key focus for investors to consider as both telecom giants press their largest acquisition efforts in a generation.

Verizon provided clear guidance on both its forecast earnings per share growth and its dividend growth when announcing its Verizon Wireless buyout in September. The company said buying out the remainder of Verizon Wireless would immediately boost its earnings per share (EPS) by 10%, allowing it to raise its quarterly dividend 2.9% to 53 cents a share.

Verizon's deal for Verizon Wireless was considered inevitable by most analysts covering the company's shares. When the Federal Reserve changed its guidance on easing efforts in mid-2013, speculation of a deal heated up given that Verizon might never find as attractive a time to finance a Verizon Wireless buyout. In fact, when the deal was announced some analysts were disappointed by the amount of stock Verizon used in the transaction when borrowing rates were so low.

Ultimately, however, the strategy behind the Verizon Wireless deal was obvious. The company was making an all-in bet on the best asset in the U.S. wireless industry. If Verizon Wireless margins hold up amid rising competition from lower-price players such as T-Mobile (TMUS) and Sprint (S), the deal will be seen as a winner. If margins tumble, Verizon will be seen as having bought Verizon Wireless at a peak price and writedowns might ensue.

AT&T's deal for DIRECTV is different on virtually every front.

The merger has surprised some analysts, given the challenges DIRECTV faces in growing at a time when consumers are increasingly cutting the cord on pay TV bundles. That shows up in AT&T's generally vague guidance about the merger.

AT&T said on Sunday it expects the DIRECTV deal to be accretive to adjusted EPS and free cash flow (FCF) per share within 12-months of the close of the transaction. The company didn't provide any guidance on that accretion; however, it did say synergies may exceed a $1.6 billion run-rate within three years of the deal's close.

Most importantly, AT&T didn't announce any planned dividend increase. In a Monday morning conference call, the company did focus on its strong balance sheet and how that could impact future share repurchase activity without providing specific guidance.

"I don't want it to be lost on folks that we have bought back about 780 million shares over the last two years and we have a remaining 420 million authorization that exists today that is not time limited. So I'd suggest to you, as prudent and as opportunity provides, we'll have the opportunity to continue to evaluate our balance sheet," AT&T CFO John Stephens said.

So how should investors look at AT&T's deal for DIRECTV in contrast to Verizon's acquisition of Verizon Wireless?

Verizon shareholders appear likely to see the immediate benefits of the company's bet on the U.S. wireless industry. If EPS growth outruns Verizon's 10% forecasts, shareholders may soon see another dividend increase.

It is also no surprise that investors as prominent at Berkshire Hathaway, Paulson & Co., and Third Point Management disclosed stakes in Verizon in the first quarter of 2014 as the Verizon Wireless deal for came to a close. Paulson & Co received Verizon shares because of its over $1 billion stake in Vodafone; however, a source familiar with the fund said the company also bought Verizon shares on the open market in the first quarter.

Berkshire Hathaway said on Monday it was supportive of the AT&T transaction. "This is a terrific transaction for all involved," Ted Weschler and Todd Combs, Warren Buffett's investing lieutenants at Berkshire Hathaway, said in a statement. Currently, Berkshire Hathaway owns over 7% of DIRECTV's outstanding shares.

Those comments indicate AT&T may become Berkshire's next telecom sector holding, were a deal to close. To be seen is whether AT&T shareholders are as supportive. 


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AT&T shareholders have less, in the immediate term, to rely upon. EPS and FCF growth is forecast to come in 12-months after the deal closes.

The extent of AT&T's commitments such as a pricing freeze on DIRECTV service for three years, a pledge to net neutrality for three years, rising investment in rural broadband service and the company's $9 billion minimum bid in a 2015 spectrum auction also underscores that the deal faces regulatory risk.

Strategically, there are also risks.

Has the pay TV market peaked? Should investors be excited about AT&T's push into Latin America by way of DIRECTV's subscriber base in the region? Is there really much technological fit between AT&T's wireless and broadband infrastructure and DIRECTV's satellite and spectrum service? Can AT&T and DIRECTV successfully create an over-the-top video service bundle?

Those questions will now loom over AT&T as it works to close the DIRECTV deal, and in the 12-months after any prospective deal close.

"We are going to have a lot of new models emerge as a result of putting these two companies together, and that's what we're excited about," CEO Randall Stephenson said on a Monday conference call. It is unclear whether AT&T shareholders are as excited about the deal.

AT&T shares were falling over 1.5% to $36.12 in Monday afternoon trading.

Bottom Line: AT&T and Verizon entered 2014 with similar strategies and a comparable financial picture. AT&T's decision to buy DIRECTV will now create clear distinctions when compared against Verizon's bid for full control of Verizon Wireless.

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-- Written by Antoine Gara in New York.

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