The Federal Communications Commission (FCC) recently put the long running review of the proposed takeover of Time Warner Cable (NYSE:TWC) by Comcast (NASDAQ:CMCSA) on hold.  The FCC has further stated that it can restart the review as it sees fit. The merger, which will make the combined entity the largest pay-TV operator in the U.S., has garnered a lot of negative attention since it was announced in February of 2014. As we wait for the FCC to restart its review, we still believe that the merger should be approved and have incorporated this into our price estimate for Time Warner Cable. Our price estimate for Time Warner Cable is $158, roughly in line with the current market price. However, we note that uncertainty surrounding the deal has increased due to recent developments related to the FCC.
What Recent Developments Can Affect The Deal
- Time Warner Cable Q1 Review: High-Speed Data Leads Revenue Growth, Company Gains Pay-TV Subscribers
- How Are Time Warner Cable’s Revenue & EBITDA Composition Expected To Change By 2020?
- What Has Led To A ~20% Increase In Time Warner Cable’s Revenues & EBITDA In The Last Five Years?
- How Has Time Warner Cable’s Revenue Composition Changed In The Last Five Years?
- How Much Can Time Warner Cable’s Revenues Grow Over the Next Five Years?
- What’s Time Warner Cable’s Fundamental Value Based On Expected 2016 Results?
Concerns had already been raised by critics that the merged entity will yield too much power in the pay-TV industry as the combined market share for the two companies is around 33%. Comcast has taken steps to alleviate this concern. (Read More – Comcast-TWC Merger Makes Sense Despite Ever Growing Opposition) However, the new ruling by the FCC, which changed the definition of broadband, has raised anti-trust issues regarding the merged entity’s share of the high speed Internet market as well. Earlier in the year, the FCC changed its definition of broadband Internet by revising the required download speeds to 25 Mbps or faster as opposed to the earlier speed limit of 4 Mbps.  Under the earlier definition, the combined entity would have represented just under 37% of the high speed internet market with Time Warner Cable and Comcast accounting for 13% and 24% respectively.  However, Comcast’s share market share jumps to approximately 57% under the revised definition of broadband services. 
Comcast officials have argued in favor of the deal by stating that Comcast’s market share will increase by only one percent after the merger is complete.  Time Warner Cable officials on their part have said that the revision in the definition is “arbitrary” and will not have any implications on the deal’s regulatory approval.  However, Section 706 of the Telecommunications Act of 1996 states that the FCC has to determine whether the broadband service is being deployed to Americans in a reasonable and timely way.  If the FCC’s determination is negative, it has to take immediate action to accelerate deployment by removing barriers to infrastructure investment and by promoting competition in the telecommunications market. The FCC could look at Comcast’s already large market share as an impediment to promoting competition and might not look at the deal favorably.
Critics of the merger have argued that Comcast could use its considerable power in the broadband market to disrupt online streaming services. These streaming services have been slowly chipping away at cable pay-TV services for a while now and both Time Warner Cable and Comcast have lost pay-TV subscribers as a result. Comcast’s viewpoint is that its large share of high speed Internet connections is the result of the investments the company has made in its infrastructure. This improved infrastructure allows the company’s customers to consume bandwidth-intensive services such as video streaming with ease. The recent actions taken by the FCC have firmly established that the commission wants to establish a free and fair Internet. It recently passed new regulations that will help it regulate the internet more like a utility. (Read More – FCC Ruling On Net Neutrality Will Have Major Implications For The Internet Space) Considering FCC’s recent stance, it might ask for concessions from Comcast in lieu of the merger which might result in the merger not making economic sense for the company.
Why The Deal Is Important To Time Warner Cable
The companies have said that the transaction will generate approximately $1.5 billion in operating efficiencies. Moreover, the combined entity will benefit from the merger synergies, especially on the advertising front. The merger is expected to help the combined entity’s pay-TV business the most and could potentially have an impact on the rising content costs. The pay-TV industry has been battling with content owners over distribution agreements for the last few years. An increase in carriage fees directly impacts the end customer as cable companies tend to pass on these costs to their subscribers. If the merger goes through, the combined entity will service roughly 30% of the pay-TV market and will gain significant leverage on the distribution front. The company can potentially reshape the entire industry and tame the content owners over distribution fees as content owners will not be able to afford losing such a large number of viewers. These operating efficiencies, coupled with reduced content costs, should improve operating margins. This could potentially stabilize the consumer subscription fee that has been increasing consistently over the past decade.
What Happens If The Deal Does Not Go Through
All is not lost for Time Warner Cable if the merger does not receive regulatory approval. Charter Communications (NASDAQ:CHTR) has expressed interest in acquiring Time Warner Cable if the current deal fails.  The company had also made a failed bid for Time Warner Cable in early 2014. Charter is the fifth largest pay-TV provider in the U.S. with just under 4.2 million subscribers and also provides Internet services to more than 5 million subscribers.   Just like the Comcast-Time Warner Cable deal, Charter’s potential merger with Time Warner Cable would also generate operating efficiencies. Furthermore, the deal with Charter would face less regulatory scrutiny, compared to the current Comcast deal, as the potential combined market shares in both the pay-TV and Internet businesses would be smaller.
Time Warner Cable has also been doing well for itself lately. (Read More – Why We Are Revising Our Price Estimate For Time Warner Cable) The company reported its fourth quarter and full year earnings on January 29th. The subscriber numbers were very positive for the company. The full year increase to the high speed Internet subscriber base was 657,000 as compared to 211,000 in 2013.  The company also lost fewer Pay-TV subscribers in 2014 as compared to the previous year. The company was able to avoid the lower customer satisfaction levels and frequent blackouts of various networks witnessed in the past and it will be interesting to see if it can maintain this momentum. For the year 2015, we estimate the company’s revenues will be around $23.8 billion, compared to consensus estimate of $23.9 billion, and an EPS of $8.28, compared to a consensus estimate of $8.10.
View Interactive Institutional Research (Powered by Trefis):Notes:
- FCC Puts Review of Comcast-Time Warner, AT&T-DirecTV Deals on Hold, March 13, 2015, Wall Street Journal [↩]
- Faster Internet: FCC Sets New Definition for Broadband Speeds, NBC News [↩]
- MAJOR PAY-TV PROVIDERS LOST ABOUT 125,000 SUBSCRIBERS IN 2014, March 3, 2015, Leichtman Research Group, Inc. [↩] [↩]
- REDACTED – FOR PUBLIC INSPECTION, Comcast’s SEC Filings [↩]
- Comcast now has more than half of all US broadband customers, January 30, 2015, arstechnica.com [↩]
- Time Warner Cable’s (TWC) CEO Rob Marcus on Q4 2014 Results – Earnings Call Transcript, January 29, 2015, Seeking Alpha [↩]
- Broadband & Sec 706, cybertelecom.org [↩]
- Charter Ready To Go After Time Warner Cable If Comcast Deal Falls, March 3, 2015, Variety [↩]
- 3 MILLION ADDED BROADBAND FROM TOP PROVIDERS IN 2014, March 5, 2015, Leichtman Research Group, Inc. [↩]
- Time Warner Cable’s SEC Filings [↩]