Overview of the deal
Acquirer: AT&T (NYSE: AT&T Inc)
Target: Time Warner (NYSE: TWX)
Estimated value: $85bn ($108.7bn including net debt)
Announcement date: 22/10/2016
Acquirer Advisors: JP Morgan, Bank of America Merrill Lynch
Target Advisors: Morgan Stanley, Citi AT&T and Time Warner are not direct competitors.
Combining the digital content distributor AT&T with the entertainment and news provider, Time Warner, would be a classical vertical merger. The telecommunications industry become vibrantly competitive and innovative following several technological disruptions that has forced older companies to adapt their business strategies. It is reasonable to assume that this vertical merger could lead to more efficiencies and synergies, hence benefiting both companies in this new environment.
For AT&T this deal is strategically very important to gain more data about its internet users and wireless subscribers. In addition, this deal could help AT&T more accurately target advertising to consumers and so compete more successfully with digital platforms such as Alphabet Inc.’s YouTube and Facebook Inc. However, in order to become the world's largest content and distribution company, AT&T has still to overcome opposition from the Department of Justice
The view presented here is that the government’s antitrust case has “little to no legal or economic basis”. They cite how traditional media companies have been losing ground to “new entrants and new forms of content”, that already utilise a vertically integrated business model. -Forbes
Company details (AT&T)
AT&T is a multinational conglomerate and the world's largest telecommunications company, serving 71 million customers.
- Founded in 1983 and headquartered in Dallas, United States
- President and CEO: Randall Stephenson (since 2007)
- Number of employees: 246,750
- Market Cap: $221.31bn - EV: $336.30bn
- LTM Revenue: $160.55bn - LTM EBITDA: $45.83bn
- LTM EV/Revenue: 2.20x - LTM EV/EBITDA: 7.61x
Company details (Time Warner)
Time Warner is a global leader in media and entertainment. The company has major operations in film and television and consists of three divisions, including HBO, Turner Broadcasting System and Warner Bros.
- Founded in 1990 and headquartered in New York City, United States
- CEO: Jeff Bewkes (since 2008)
- Number of employees: 25,000
- Market Cap: $72.07bn - EV: $93.23bn
- LTM Revenue: $31.30bn - LTM EBITDA: $8.61bn
- LTM EV/Revenue: 3.09x - LTM EV/EBITDA: 10.92x
Projections and assumptions
As the net neutrality law was replaced in the US in December, it would no longer be illegal for internet service providers to hamper speeds, control licensing and offer preferential treatment. The DoJ could therefore argue that there would be no restrictions on AT&T to exploit the market. AT&T could hamper the video quality, limit streaming speeds for its competitors and in addition force streaming services to pay higher fees. Hence, the merger is potentially anti-competitive and harmful to the industry.
If the deal clears, AT&T´s overall debt would spike to up to $182 billion and hence increase AT&T´s overall leverage dramatically. This is about three times the volume compared to overall debt just three years ago and would make up three times the combined company's EBITDA of $59 billion. However, the merger is expected to provide significant financial benefits, including lower capital intensity and a much more diversified revenue mix.
AT&T expects savings up to $1 billion in cost synergies within three years of the agreement. Time Warner would make up 15% of total revenue and enable an expansion for AT&T into Latin America, as Time Warner owns a major stake in HBO Latin America.
Once the merger finalises, AT&T’s new, vertically integrated business model would enable them to sidestep the stagnant trend of older broadcasting companies, provided they manage to escape the DoJ’s accusation of antitrust and are able to effectively utilise the synergies created. On the former point AT&T’s CEO has issued a statement of confidence in the proceedings, and there are no obvious obstacles to the latter. In this scenario their aim of competing with Netflix and Amazon’s video streaming services would be supported by the significant economies of scale at their disposal.
This approach would be centred around Home Box Office Inc. (HBO), Time Warner’s division most capable of competing with the rapidly growing prominence of Netflix and Amazon prime video. Both of these are looking to capture greater market share by themselves by producing the entertainment content they host on their platforms. As HBO already has a video streaming platform and its own entertainment franchises with a very strong presence in popular culture, AT&T would stand to gain a direct entry point for further expansion into the market.
Furthermore, in the scenario where AT&T goes forward with, and is able to carefully take advantage of, the new net neutrality regulations in the US and implement network throttling without upsetting their consumers, they stand to gain a significantly broad base of revenue generation.
Risks and uncertainties
While the deal stands on sound, familiar ground in theory, as a vertical merger there are several factors that could lead to disruption in practice. Most obvious is the antitrust challenge by the DoJ, but more significantly, the uncertainty that this process creates by being associated with the Trump administration. Amidst worries of White House interference, this is underscored by the Assistant Attorney General of the Antitrust Division being appointed by the Trump administration.
Even if this risk is overcome, there still remain several hurdles on the road to a fully successful merger. The main problem for AT&T successfully competing with Netflix and Amazon lies in the relative market size of HBO compared to these two platforms, currently HBO stands at 3.5 million subscribers out of a global total of 131 million, compared to Netflix’s 100 million subscribers. So there is still uncertainty regarding whether AT&T’s investment into the merger will be enough to let them compete directly with video streaming platforms.
These two risk factors amplify the underlying debt risk that AT&T is taking on, seen, as an example, in the $22.5 billion bond sale they put out in late July, 2017. The inherent riskiness in this, coupled with higher interest payments, makes a smooth integration of Time Warner crucial.
The Economist judges the deal to be financially unsound, pointing to that “perhaps half of Time Warner’s profits come not from making brilliant series” but from selling bundles of TV shows at inflated prices to cable TV. They claim that the only way to reconcile this would be for AT&T to abuse its market position, and that the deal comes about misaligned incentives in AT&T’s executive compensation scheme.
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