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How AT&T-Time Warner Could Usher in a New Era of Megamergers

The mating dance is in full swing: The rushed wedding of AT&T and Time Warner marks a sharp acceleration in the latest wave of merger mania for media companies.

But this isn’t like the unbridled empire-building of past consolidation booms — say, the exuberant 1990s, when Time Inc. and Warner Bros. first came together, or when Disney added ABC to its kingdom. Instead, the current combination seems to be driven by fear of an uncertain future. The volume of concerns facing the industry has risen to a new pitch. Will pay-TV crumble — and if so, how fast? What will be the next generation’s dominant media platforms?

However the matchmaking plays out, the composition of the media conglomerates dominating the global film and television business will likely look very different a year from now. The pressure is on, as demonstrated by AT&T’s mad dash to complete an $85.4 billion merger deal in barely a weekend’s time, lest one of the Four Horsemen of Hollywood’s Apocalypse — Apple, Google, Amazon, and Facebook — beat the telco giant to grabbing Time Warner’s assets.

Jonathan Carlson for Variety

The union of Time Warner’s blue-chip brands (HBO, Warner Bros., and Turner) coupled with AT&T’s pay-TV stronghold in DirecTV — its nationwide wireless footprint boasting 54 million consumer subscribers and a solid broadband backbone — creates a vertically integrated behemoth. Only Comcast, with NBCUniversal, is a real peer. The deal also gives AT&T/Time Warner new potential to supercharge its over-the-top, direct-to-consumer strategies (think HBO Now and AT&T wireless).

Time Warner CEO Jeffrey Bewkes began his conversation with AT&T CEO Randall Stephenson in late August with the promise that he wasn’t looking to sell. The two started out talking about innovative partnerships they might try in multiplatform distribution and video-on-demand. But as the CEOs realized they shared a similar view of the future, the discussions moved quickly to a full-blown acquisition. Stephenson described it as a process that had its own “gravity.”

“We think this is great for continued innovation in content,” Bewkes said when talking up the merger the night it was announced. “We think it’s great to support the investment in good content. … AT&T has the reach and the capability to make really good advances for consumers in terms of convenience, mobility, price, and package in a way that, I think, once everyone sees how good it is, you are going to see all kinds of other distributors following. And then you end up with a kind of revolution in television.”

Time Warner and AT&T confined their talks to a tight circle of executives at the highest levels. The teams met several times over the past two months, both in Time Warner’s backyard of New York and in AT&T’s hometown of Dallas, as well as in other cities. Bewkes and Stephenson reached a handshake agreement in principle shortly after the Columbus Day holiday, and from there it was a matter of pounding out the details and legal fine print. The two CEOs were in different cities on the evening of Oct. 22 when the deal was clinched. The formal announcement came only about an hour after the 10 members of Time Warner’s board met in person in New York to unanimously approve the deal, just as AT&T’s board had done earlier in the day.

In selling the benefits of the merger, Stephenson said his company needs more scale in content in order to offer the services consumers want. He referred to “pain points” in the haphazard way that programming is distributed online vs. linear TV. He sounded like a CEO who has had an earful from customers about the peculiarities of accessing programming on a tablet vs. a smartphone vs. a desktop computer vs. VOD. The 56-year-old exec, who got his start in 1982 with Southwestern Bell Telephone, has some experience with an industry in transition.

“As we try to think about curating content differently … doing that at arm’s length negotiations is really, really hard, and it’s really, really slow,” Stephenson said. “In an industry that’s iterating as fast as this one is iterating, you’ll fall behind. If you put [AT&T and TW] together you can begin to iterate these new types of services and innovate much faster and get it to market much faster.”

Outward Bound: Time Warner CEO Jeff Bewkes has acknowledged that he’ll step down after a transitional period.
AP Photo/Lionel Cironneau, File

Of course, we’ve heard this tune before. AOL and Time Warner were going to conquer the world with connectivity and premium content. The crucial difference 16 years after that disastrous merger — considered one of the worst debacles in M&A history — may be that now consumers are demanding the kinds of services that Stephenson wants to sell them, as opposed to a mega-corporation conjecturing that maybe someday the content-communications nexus would make sense. To Stephenson and Bewkes (who was running HBO during the AOL Time Warner fiasco), that day is now here.

Although the tie-up still faces a rocky regulatory road, the sheer size of the new company will put pressure on smaller rivals in both the content and distribution camps to bulk up.

Look no further than CBS Corp. and Viacom, which are already trying to hammer out a shotgun marriage at the behest of their patriarch, Sumner Redstone, and daughter Shari Redstone. If they weren’t forcing the issue, both companies would be seen as prime M&A targets. Smaller but significant companies like Discovery Communications, AMC Networks, and Scripps Networks Interactive, as well as Lionsgate, Sony Pictures, MGM, ITV, and Netflix, are more in play now than they were last week, thanks to Stephenson’s hunger for Time Warner.

Disney and 21st Century Fox have the challenge of figuring out what cards to play amid the rush. The biz has been abuzz that Disney CEO Robert Iger is plotting one last big buy — perhaps adding to his legacy of acquiring Pixar, Marvel, and Lucasfilm — before he bows out in 2018. Industryites have also been curious about whether the younger generation of Murdochs now running 21st Century Fox will have the same zest for chasing big-game deals as does their father, Rupert Murdoch. (For now, sources say, Fox is out of the hunt for Time Warner, which rejected Fox’s $85-a-share overture in 2014). Time Warner was seen as an unusually attractive prize for AT&T because it was, for the right price, a motivated seller. Bewkes’ spinoffs of Time Warner Cable, AOL, and Time Inc. have positioned it as a more digestible bundle of top media and entertainment properties. And unlike with Viacom and Fox, Time Warner has no blocking/family shareholder with an iron grip on the company, à la Redstone or Murdoch.

The timing of the AT&T/Time Warner deal was fueled by the stormy business environment for traditional media. Digital disruption is forcing studios and networks to reinvent decades-old business models as profit centers shift and, in some cases, evaporate. The possibility of a behemoth with the reach of Google or Facebook muscling into the pay-TV business suddenly doesn’t seem merely hypothetical. What’s more, a new generation of consumers who turn to YouTube stars and social-media feeds for entertainment are proving less receptive to Hollywood’s traditional products.

The shift in the way post-millennials consume entertainment is the only thing more worrisome for showbiz CEOs than the steady migration of TV viewing away from the linear platforms that are still the cornerstones of how Hollywood makes its money — for now.

With networks and studios under pressure, and cable, satellite, and telco TV providers feeling the cord-cutting squeeze, the “bigger is better” mindset has roared back into vogue. Pay-TV operators want leverage against hard-driving programmers — which is why Time Warner Cable and Cablevision were scooped up in the past year (by Charter Communications and Altice, respectively).

Programmers are looking to amass market share with as many must-have channels and production resources as can be pulled under one roof. AT&T looked at Starz before setting its sights on the bigger target of Time Warner. Starz went to Lionsgate earlier this year, and it’s a deal that seems like the appetizer for what could be a three- or four-course meal for Liberty Media chairman John Malone over the next few years.

$85.4b$21b

By the Numbers
AT&T’s agreement to buy Time Warner marks the most expensive deal for a content company since AOL and Time Warner tied the knot in 2001.
The cash-and-stock transaction values Time Warner at $107.50 per share. That’s a 36% premium over Time Warner’s closing price on Oct. 19 ($79.24).
$85.4b $21b $106.4b
Time Warner equity value Time Warner net debt Total transaction value
Time Warner shareholders will receive $53.75 in cash and $53.75 in AT&T stock.
They will own 14.4% to 15.7% of AT&T, depending on the closing share price, when the deal is completed.
Termination fees:
Time Warner will pay AT&T $1.7 billion if it backs out of the agreement.
AT&T will pay Time Warner $500 million if it cannot obtain regulatory approvals.
AT&T’s 2015 revenue Time Warner’s 2015 revenue
Time Warner will contribute 15% of AT&T’s total revenue after the deal.

The AT&T/Time Warner combo falls into the more rarified air of vertical integration, combining MVPD, high-speed internet, and content muscle. The telco pitched its rationale for the merger as centering squarely on improving its ability to compete in the new world, where the hotbed of media consumption is shifting to the smallest, most portable screens.

The rich price that AT&T is willing to fork over for Time Warner cements Comcast’s status as the preeminent 21st-century conglomerate, with its mix of cable and broadband heft and NBCUniversal’s content operations. Comcast has become a darling of investors for the breadth of its portfolio. The steady returns of its industry-leading cable business have offset the more volatile performance of the film, TV, and theme-park operations at NBCUniversal.

But the content businesses give the company more sizzle and greater reach with movies, TV shows, and even channels that travel around the world. In truth, the cable and broadband side of Comcast and NBCU haven’t teamed to reinvent the wheel of producing and distributing film and TV so much as both arms of the colossus have been able to function well in their respective lanes.

AT&T is seeking a more vertically integrated content and distribution mix as it faces big headwinds in its core businesses: For the third quarter, its total wireless revenue was $18.2 billion, down 0.7% year over year — and wireless subscription growth is slowing, while TV and broadband subscribers declined sequentially. The wireless telephone and data market is rife with competition, stalling growth for the largest players, including AT&T’s chief rival, Verizon. AT&T was blocked by regulators in 2011 from acquiring smaller competitor T-Mobile, a development that put the kibosh on growth in wireless through acquisitions.

AT&T’s pursuit of DirecTV in 2014 signaled its interest in diving deeper into video and entertainment. But the decision to go after Time Warner barely a year after betting $49 billion on the satellite TV provider surprised the industry, given that AT&T’s debt load will balloon to nearly $200 billion with the acquisition (up from $117.2 billion as of Sept. 30). But AT&T is betting it will have the earnings heft it needs to tame that leverage down the road. The combined entity will generate more than $60 billion in operating income, and is on track to deliver an estimated net income this year of about $19 billion.

“AT&T has the reach and capability to make really good advances for consumers.… Once everyone sees how good it is, you are going to see all kinds of other distributors following. And then you end up with a kind of revolution
in television.”
Jeff Bewkes, Time Warner

But even though AT&T and Time Warner sprinted to the deal’s finish line, M&A on this scale does not get the seal of approval overnight. It’s likely that government review of the proposed merger will take a year or longer, given the magnitude of the transaction. Financial analysts also warn that the 2016 presidential election adds an extra degree of uncertainty to the timeframe for the deal, given the new administration and the transition of power.

Donald Trump has already said he would work to block the transaction, while Hillary Clinton’s running mate, Tim Kaine, expressed concerns about whether the deal would decrease marketplace competition. And it’s worth noting that the Democratic party platform this year calls for “reinvigorating” antitrust enforcement.

Given the history of blocked mergers in recent years, it’s unrealistic to view a deal’s regulatory green light as a slam-dunk. The Dept. of Justice’s antitrust division would likely review the merger, and in the past it has given rivals the opportunity to share their concerns about transactions in private.

What is unclear is what role the FCC will have. The Commission has reviewed past mergers, like Comcast’s acquisition of NBCUniversal and AT&T’s proposed deal with T-Mobile, but its oversight was triggered as the companies had to apply for the transfer of broadcast and spectrum licenses. In contrast to the DOJ’s review, the FCC’s process tends to be public in scope, with periods for public comment on the transaction and for the companies to respond. The FCC analyzes whether a merger is in the public interest, a standard that can invite a wider swath of concerns.

Whatever the case, it’s likely that an array of interest groups will line up to call for significant conditions on the deal — or even for it to be blocked.

So, for Stephenson and Bewkes, it’s looking like at least 12 more months of mostly business as usual before they can fully embrace the future. The one thing AT&T can count on between now and then is that the competitive fray will only be more complicated — and likely consolidated — by the time they toast the closing of the deal.

Ted Johnson contributed to this report.

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