AT&T currently owes over $150 billion in debt, but sub-2% bond interest rates and lucrative broadband business give the company extreme confidence in managing these colossal numbers.
Photo credit: Roberto Machado Noa (Getty Images)
At the recent 23rd Annual Oppenheimer Conference, AT&T Chief Financial Officer John Stephens discussed the company's strategies and current position to handle its $152 billion in debt, and gives slight inference on whether or not WarnerMedia's WB Games division will be sold. Reports say Warner Bros., who is wholly-owned by AT&T, will sell of its gaming division in a $4 billion deal that includes all major game studio subsidiaries like Netherealm, Monolith, WB Montreal, and Rocksteady.
The sell-off would be primarily motivated by chipping away at the company's massive debt, while also setting WarnerMedia up for recurring royalty fees as it licenses its franchises and IPs out to third-party developers instead of investing the millions themselves. This would eliminate a portion of WarnerMedia's spending while simultaneously netting a big billion-dollar influx of cash to help reduce the debt or reinvest into other services, like HBO Max.
The WB Games division has a number of studios working on high-profile games including:
- Rocksteady Studios - New Suicide Squad live game
- WB Montreal - Batman Gotham Knights game
- Netherealm - Mortal Kombat 11 and possibly Injustice 3
- Avalanche - New Harry Potter RPG
WarnerMedia is currently going through rounds of layoffs as it restructures its branches under a unified Studios and Networks banner. WB Games is now part of this umbrella, but gaming takes a backseat to direct-to-consumer interactive content like HBO Max, which the AT&T CFO describes as the "most exciting" aspect of the new structure.
The Oppenheimer event gives some more inference into AT&T's thinking about managing its debt, which could ultimately affect the future of WB Games.
AT&T's current total debts sit at $152 billion as of Q2'2020.
AT&T's debt confidence
AT&T isn't too worried about its massive debts. That's not to say it's not a top priority, but the company is confident it can properly manage it for a number of reasons.
A big reason for this confidence is the low bond interest rate AT&T is currently enjoying. The company just issued $30 billion in 10-year bonds at a sub-2% interest rate, which is quite favorable. Years ago the interest rate was at 6-7%.
This takes a lot of the pressure off of AT&T and reduces the amount they have to pay to borrow money. AT&T now has more flexibility to manage its debt and invest into core frameworks and services that power its billion-dollar ecosystem.
Companies sell bonds as a kind of IOU. It's a debt that's promised to be repaid. Investors pay the company for the debt, or the promise of their original investment returned back over a period of time. An interest rate is attached so the investor receives more money than they put in.
AT&T's current 10-year bond interest rate is just 1.9%, meaning investors will get the principal plus 1.9% returned back to them over a ten-year period.
Low bond interest rates are tremendously positive for the company that issues the bonds. It means they have to pay less money back over time.
Companies get low bond interest rates depending on their creditworthiness. AT&T is obviously seen as a safe risk.
"Our 10-year bond is traded below 2%, around 1.9%, somewhere around there in the last few days. I know market rates are low, but quite frankly, that's the lowest it's been traded since I've joined the company in the early 90s," AT&T Chief Financial Officer John Stephens said at the Oppenheimer conference.
"So the bond market, not only are interest rates low, but they have faith, they are convinced we are a good credit risk. You've seen that in the last three debt offerings we've done, over $30 billion in the last two months, all in very long terms, all very good rates, so quite frankly there's a big section of the bond market that believes in our ability to generate cash year-in and year-out for a very long time.
"I think we're more optimistic in our ability to generate more cash than the market realizes at this time."
This kind of flexibility seems to bode well for the games division. If AT&T is less pressured, it may not decide to sell off WB Games and instead see the interactive segment as a means of generating long-term millions. It all depends on the investment vs payoff ratio, and how much debt AT&T plans to pay off.
The fate of WB Games, which is responsible for Batman, Superman, Harry Potter, and Lord of the Rings games, remains uncertain.
AT&T will pay down debt to a more 'comfortable level'
When asked what was the right amount of debt or a debt target, e.g. whether or not a debt reduction to $130 billion or $120 billion was a goal, Stephens said the company would continue paying off debt until it was at a more comfortable level.
This is a major motivation behind WarnerMedia's new restructuring into a leaner and more COVID-adapted business. It could also be a big reason why WB Games is sold off. Ultimately, the messaging isn't clear, and it could go either way for the gaming branch.
"We're going to continue to pay down debt. It's not a cost of debt issue. The rates are really low, and quite frankly the interest expense compared to EBIDTA today is very favorable, compares very well to back in the days when we had much less debt at 7%. If you think of it that way, the interest costs compared to our EBITDA are really good shape historically.
"The issue is really the quantity of debt. You know, $150 billion is a large number. So getting that down into a more comfortable level, where the marketplace is more comfortable and is wider, that's important. We've expanded our borrowing in Europe with the pound sterling, it's a variety of different sources and that's kept us with the ability to borrow and get very good rates."
Stephens asserts that chipping away at the debt is still a top priority. Just because they have more flexibility only makes things a bit easier, but it doesn't take away the responsibility to repay debtholders.
"But bringing the quantum of debt down is still important. It's not so much the rate or the ability to manage it that're an issue--you know, the rate's great, and we have great flexibility in managing the debt.
"With that being said, with interest rates at today's level, it gives you a whole different view in how much debt...you have to analyze how much debt you carry, it's not the same as it used to be, when it was 6-7% 10-year rates.
"Now it's under one-third of that. It doesn't mean you immediately multiply that by the amount of debt, but it does mean you have to look at things differently just from a total cash/cost of capital perspective, as well as the total cost of capital, or the share of earnings.
"We look at that all the time and that's on the top of the list.
"We're going to continue to pay down some debt because that's going to get the quantum of debt down. We think that's an important message to continue to send to our bond investors."
Free cash flow and low bond interest
Even with all of that, the CFO doesn't have a target in mind for the debt--at least right now. Stephens says the debt is a 'very manageable situation' thanks to the company's billions in free cash flow after dividends.
"I don't have a target to announce today. But certainly $130 billion is better than $150 billion, and $120 is better than $130. But I'll just go back to...if you just do the simple math on the rate differential, 6:2%, for example, you can understand that going down to historic levels of debt may not be appropriate for this environment.
"We are certainly well aware of that and thinking about it.
There's plenty of free cash flow after dividends. Plenty of cash flow to pay down debt, and plenty of flexibility to invest in the spectrum.
"My point is our strength of free cash flow in our core wireless broadband business cash-generating machines, it's really a very manageable situation. And now quite frankly, in the last few months, being able to turn out our debt and do $30 billion in issuances in a weighted 20-30% average net debt at extremely low rates, the flexibility just gets even stronger."
Right now it's tough to determine whether or not WB Games will be sold.
AT&T is sending mixed messages; it's confident it can not only handle the $152 billion debt, but generate consistent free cash flow to reinvest and pay out. At the same time, it says it wants to reduce the debt to a more comfortable level, which could mean shedding of non-essential and potentially financially risky businesses like the games division.
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