The proposed Time Warner buy would create more problems than solutions for AT&T, said Chris Antlitz, senior analyst at TBR.
AT&T plans to buy Time Warner for $85.4 billion, using a 50/50 mix of cash and stock, as well as take on nearly $25 billion in debt.
If the deal passes regulators, it will bring together the world’s largest pay‐TV operator and a marquee content conglomerate, creating a vertically integrated media giant larger and more pervasive than Comcast. AT&T expects the deal to close by the end of 2017.
Why AT&T wants Time Warner
There are a few key reasons why AT&T wants Time Warner want to acquire: Acquiring Time Warner would enable AT&T to reduce its content acquisition costs, which is the largest and fastest growing expense in its pay‐TV business.
The acquisition would provide a new source of revenue growth, albeit inorganic, for AT&T, whose traditional connectivity business is shrinking on an organic basis.
Time Warner would open the door for AT&T to repackage content and bolster its over‐the‐top (OTT) offerings to millennials.
By pairing Time Warner’s content with AT&T’s distribution channel, AT&T would be able to sell more lucrative targeted digital advertisements.
On a net basis, this deal is about having leverage in the pay‐TV ecosystem as well as gaining market share and margin protection. Regulatory implications AT&T would likely have to make substantial concessions, similar to what Comcast agreed to in order to seal the NBCUniversal deal, for the Time Warner deal to get approved by regulators.
Concessions would likely include, but not limited be to, agreeing that Time Warner’s content would be available to all service providers at fair terms, including OTT players such as Netflix. Privacy is another area that would receive scrutiny. With AT&T and Time Warner trumpeting the additional data they would collect on subscribers and monetize via advertising, regulators will want to ensure consumer privacy is protected, and there would likely be concessions in this area that AT&T would have to agree to.
Should the deal fall through, AT&T would be on the hook to pay a $500 million breakup fee, much less than the $4 billion fee it paid to T‐Mobile in 2011 after that deal fell through.
Capex implications
A chief market concern is the Time Warner acquisition would add to AT&T’s already high debt load, causing a credit rating cut and limiting its ability to invest in its network. Another challenge is the growing popularity of exclusive content offered by inexpensive or ad‐based OTT providers such as Netflix and YouTube, which lessens the appeal of Time Warner’s content.
With the dividend sacrosanct, AT&T would have to select other means to manage its interest payments and pay down debt to stabilize its credit rating, which heavily influences the interest rate AT&T pays on its debt. Noncore asset divestitures, such as DirecTV Latin America, are one path, but the fastest and most efficient way to raise funds is to cut Capex. With that said, TBR believes AT&T would reduce capex in 2017 from 2016 levels, and keep Capex suppressed over the next few years to stabilize its finances post‐acquisition and bring its net debt to adjusted EBITDA ratio back to historical levels.
Cutting Capex could imply reduction in scope of key initiatives, such as LTE densification and fiber deployment, areas that are critical to staying competitive. Media industry implications AT&T’s potential buy of Time Warner highlights a larger industry trend, whereby operators want vertical integration with media to remain relevant and protect their core connectivity and pay‐TV businesses as the industry shifts from traditional models to a digital, OTT model. Comcast has already committed to this path via its acquisitions of NBCUniversal and DreamWorks Animation, and now other media companies are feeling pressure to do deals to stay competitive.
Verizon is also following suit via its acquisitions of AOL, Complex Media, AwesomenessTV and potentially Yahoo. Alphabet, Apple, Amazon, Facebook, Twitter and others have all been speculated to be interested in acquiring video content properties and or content rights in a bid to play a role in the evolving media ecosystem and enhance the value of their core businesses. Though industry players are moving in this direction, the benefits of this strategy have yet to be proved.
Is this a good deal for AT&T?
Though there are some benefits from AT&T owning Time Warner (content cost synergies, advertising leverage, speed to market with new video offerings, etc.), TBR believes the negative impacts of the deal far outweigh the benefits.
Among the negative impacts:
AT&T offered to pay a substantial premium for Time Warner, limiting shareholder returns and the operator’s financial flexibility
Concessions would limit AT&T’s ability to leverage Time Warner’s assets Debt overhang would create difficult cash allocation choices and could lead to higher interest rates
Expected capex reduction could narrow the performance gap between AT&T’s network and competitors
Time Warner would dilute AT&T’s attention on its core business
Time Warner has substantial challenges of its own, namely struggling with declining sales as it tries to adapt to an OTT world
AT&T’s best bet is to focus on building and maintaining a competitive edge in its core business (connectivity and digital media distribution) and taking more market share in that space, while also expanding its portfolio globally.
Investments in NFV and SDN, fiber, Internet of Things and other areas will all enable AT&T to outperform the competition in its traditional business and drive incremental, profitable growth even as its industry struggles with revenue and profit declines.
Due to the aforementioned issues, TBR believes that buying content and becoming a vertically integrated media company would not likely pan out as AT&T expects.
