Why AT&T Is Buying Time Warner

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AT&T (NYSE:T) announced that it will acquire Time Warner in a stock and cash deal valued at $85.4 billion, integrating its vast distribution network, which spans wireless and broadband services and pay TV, with Time Warner’s media assets, which include the major cable networks CNN and HBO and Warner Bros Studios. [1] The transaction, which is subject to approval from Time Warner shareholders and the U.S. Department of Justice, is expected to close before the end of 2017. Below, we outline some of the key takeaways from the deal.

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How Time Warner Helps AT&T

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AT&T has been increasingly interested in the media and content businesses as growth in its core wireless business has slowed, while its landline businesses are in decline. Last year, the firm closed a $49 billion deal to buy DirecTV in a move that made it the nation’s largest pay TV operator. With the deal came over 25 million customers and a swath of highly valuable content agreements. The carrier has been focusing on widening its distribution footprint, with plans later this year to launch its own streaming TV service targeting cord cutters, DirecTV Now. By acquiring Time Warner, AT&T would own high-quality original content, besides gaining some bargaining leverage in acquiring content from other companies for distribution. Rising content costs are becoming an issue for pay TV players, as customers opt for smaller TV bundles or switch to web-based streaming services altogether. Moreover, the firm expects $1 billion in annual run rate cost synergies within three years of the deal closing, driven primarily by corporate and procurement expenditures. There could be revenue synergies as well, although we expect this to be somewhat limited.

The Price Is Probably Right 

AT&T will pay $107.50 per share of Time Warner in a half stock and half cash deal. This marks a 35% premium over Thursday’s closing price, before reports of a potential deal emerged. While the premium is significant, it is probably justified. Firstly, the deal price is roughly in sync with our $105 fair value estimate for Time Warner stock . (See our detailed Time Warner model and estimates here.) Moreover, AT&T expects the deal to be accretive to its adjusted EPS and free cash flow per share in the first year post close and things should improve further as cost synergies kick-in. Additionally, Time Warner is one of the few pure-play media players that is acquirable. For instance, Walt Disney Company is too big and valuable ($150 billion market cap) making it hard to acquire, while 21st Century Fox and Viacom are family controlled, reducing the possibility of a takeover. Time Warner has been unlocking value by spinning off under-performing businesses (AOL, magazines, cable), while focusing on more lucrative video content.

AT&T’s Mounting Debt Load Is A Concern

AT&T’s net debt load is already significant, standing at about $120 billion, on account of its AWS-3 spectrum purchases and the acquisition of DirecTV. To see the Time Warner acquisition through, the firm will have to take on $40 billion in bridge financing to pay the cash portion of the deal, besides having to absorb Time Warner’s $23.3 billion in net debt. This would take AT&T’s total debt load to over $180 billion. While AT&T has the wherewithal to service this debt (it expect debt to EBITDA to be in the 2.5x range by the end of the first year post-closing) there is nevertheless a possibility that its credit rating, which stands at BBB+ at S&P, could be downgraded.

Deal Faces A Tough Regulatory Environment

The U.S. government has shown increasing skepticism towards mega-mergers and the deal is likely to be very intensely scrutinized. While anti-trust concerns typically arise when companies acquiring direct competitors, the AT&T-Time Warner deal could raise different issues, as the two firms essentially operate on the same supply chain. For instance, with AT&Ts distribution muscle, regulators will may require concessions to ensure that the firm will not favor Time Warner content over content from other media companies (more prominent channel placement on set top boxes, zero-rating data on wireless etc). AT&T must also assure regulators that it will not make Time Warner’s content more expensive for its rivals or refuse to licence content to them.

The Comcast-NBC deal merger- which is most recent large-scale deal combining content and delivery- was met with intense scrutiny in Washington, and it is likely that concerns over the AT&T- Time Warner deal could be significantly larger, given the scale of the two companies. The deal will be vetted by the next Administration and Republican candidate Donald Trump has explicitly said that he would block the merger, if elected President. The campaign of Democratic presidential nominee Hillary Clinton, who is expected to scale-up antitrust enforcement even further compared to the Obama Administration, has also raised concerns about the deal.

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Notes:
  1. AT&T Press Release []