We're still about six months away from seeing AT&T (T -0.92%) close its acquisition of DirecTV (DTV.DL). Since the announcement, DirecTV shares have traded in a relatively tight range, mostly staying between $82 and $88 per share. Of course, the acquisition agreement limits the upside return for investors, with an expected price of $95 per share, so upside is hard to come by.
Still, shares are trading 8% below that $95 takeover price, and there are several reasons investors might see that share price move higher in the next six months. Here are three of them.
The FCC resumes its review
Shares took a hit when the FCC paused its review of the merger agreement between AT&T and DirecTV. The holdup is the result of media companies that have filed a plea to prevent their contracts with the pay-TV operators from becoming public. Naturally, the media companies would lose a lot of leverage in negotiations if every pay-TV operator knew what the competition was paying.
What DirecTV and AT&T expected to take a week or two to resolve has extended to a full month now. While both are still confident the merger will gain approval, the sooner, the better, and resuming the clock will instill additional confidence in investors. More investor confidence in the merger approval and a move closer to the date will naturally push the stock price closer to the agreed acquisition price.
Last week, the merger agreement gained approval in Mexico, leaving the United States as the only major regulatory hurdle left. The combined operations of DirecTV and AT&T would be the largest pay-TV provider in the country after the combined Comcast-Time Warner Cable, so the FCC will take its time in reviewing the impact on competition in the market.
AT&T's stock price rises
Because of the nature of the merger agreement, DirecTV's stock price is now closely tied to AT&T's. Approximately $66.50 of the $95 per share will come in the form of AT&T stock, but there are some conditions built into the agreement.
DirecTV shareholders will receive 1.905 shares of AT&T stock if AT&T's stock price is below $34.90 at closing and 1.724 AT&T shares if AT&T's stock price is above $38.58 at closing. If AT&T's stock price at closing is between $34.90 and $38.58, DirecTV shareholders will receive a number of shares between 1.724 and 1.905, equal to $66.50 in value.
If AT&T shares climb above $38.58 by the time the merger goes through, DirecTV investors will effectively receive more than $95 per share. AT&T shares are currently trading in the bottom portion of the collar, though, so shares will have to rise about 9% over the next six months.
But AT&T shares don't have to rise past the upper end of the collar to affect DirecTV shares. The value of time also affects investors' expected acquisition price, so any move closer to the upper end of the collar will have an impact on DirecTV shares.
Improving cash flow from operations
If DirecTV improves its cash position ahead of AT&T's acquisition of the company, it will effectively make the purchase less expensive for AT&T. More cash left in the pockets of AT&T will make the stock rise, which is directly correlated with DirecTV's stock price.
Last quarter, DirecTV reported that its operations in Latin America were already cash flow-positive, ahead of its goal of making the region self-funded by the end of the year. Additionally, free cash flow in the U.S. more than doubled.
On the earnings call, CFO Patrick Doyle noted that the company expects a decline in capex in the U.S. next quarter, resulting in cash flow growth in the high single digits. In Latin America, he expects free cash flow to improve 20% year over year, up from previous expectations of 10% growth.
If DirecTV delivers on its guidance and sees its cash balance improve, it should cause the stock to rise as a result of a lower effective buyout price.
Nothing is guaranteed in the stock market
While there are several reasons to be bullish on DirecTV's shares -- with the $95 buyout price expected to close in six months representing an annualized return of over 16% -- remember that nothing is certain in the stock market. DirecTV's share price is affected by factors outside the company's control, so it adds risk to the investment.
Still, the merger is very likely go through once the FCC deals with the plea from the media companies. The company is operating well, and the merger presents a strong long-term opportunity for AT&T. The merger approval and subsequent close could mean much more than a quick 8% gain.
