Why I Wouldn't Vote to Sell My Time Warner Stock to AT&T

Today's investors are getting a well-positioned business and one of the biggest names in Hollywood for less than half the market cap of either Walt Disney (NYSE: DIS) or Comcast Corp. (NASDAQ: CMCSA), Warner's two closest peers. Don't expect that gulf to last forever.

Even at $85.4 billion, AT&T is getting Warner at a little more than half what it would have to pay for either of the company's larger peers. I'd just as rather have Time Warner remain an independent company and grow into the valuations that Disney and Comcast have already earned. So much for wishful thinking.

All that remains for me now is to figure out whether I'd be better off selling shares of Time Warner now and collecting the gain, or waiting to receive my share of AT&T stock and prepare for a lifetime of dividends and slow growth? Let's tackle that question in two parts, starting with AT&T's balance sheet.

In need of a lifeline

Telecom is still AT&T's core business. The company's Business Solutions group, which is responsible for providing wired and wireless service, accounted for 48.5% of revenue and 55.5% of operating income last year.

Entertainment was also a huge contributor, having accounted for 24% of revenue and 14.7% of operating profit over the same period, but at what price? AT&T's $47.7 billion acquisition of DirecTV in July of last year has been the principal growth driver in the entertainment segment. Time Warner and its $28 billion in annual revenues and $6.9 billion in operating income will now be called upon to further boost growth.

Could a cash crunch be next?

AT&T needs as much as it can get, thanks to a worsening balance sheet. Buying DirecTV added $50 billion in new debt that needs to be paid off somehow. Another $40 billion is likely on the way.

"The cash portion of the purchase price will be financed with new debt and cash on AT&T's balance sheet," the company said in a press release announcing the deal. "AT&T has an 18-month commitment for an unsecured bridge term facility for $40 billion."

How much excess cash flow could AT&T-Warner produce to begin paying down the near $165 billion in debt that would be on its books? Less than you might think. AT&T's $16.3 billion in free cash flow over the trailing 12 months dwindles to just $4.6 billion once you account for dividends. Warner has produced about $2.1 billion in dividend-adjusted free cash flow over the same period. That's $6.7 billion in total -- good, but also not that much when you're talking about funding global growth and servicing twelve figures worth of corporate debt.

Tuning out ...

Expect management to account for that by selling what it considers "non-core" assets as fast as possible and cutting costs wherever they can. Even the dividend could be on the table. I'm not keen on waiting to find out and am therefore leaning toward selling my shares when disclosure rules permit.