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AT&T + Time Warner: 3 Reasons a Merger Makes Sense and 3 Hurdles

AT&T is said to be moving forward quickly in a bid to snap up Time Warner — potentially finalizing a deal in the next few days that could be worth $85 billion or more.

Such a union would give AT&T a new avenue of growth and combine Time Warner’s premiere entertainment assets, including Warner Bros., HBO, and Turner, with the telco’s powerful DirecTV, wireless, and broadband distribution. But AT&T’s ambitions also would encounter some significant challenges.

Here are three factors that support the logic behind the vertical integration of two massive companies, and three reasons it might be tough to pull off.

1. AT&T Has Faced Stagnating Growth in Its Core Wireless and Wireline Businesses. In fact, that was the major reason AT&T bought DirecTV for $49 billion last year — to diversify and grow its revenue base. “AT&T creates value through M&A — within two years of closing a deal we assume they are looking for the next one. And as the company grows, it takes ever bigger deals to move the needle,” New Street Research analyst Jonathan Chaplin wrote in a research note. In some ways, we’ve seen this movie before: Comcast acquired NBCUniversal, bringing the No. 1 U.S. cable operator together with top TV networks and Universal Studios.

2. AT&T and Time Warner Could Accelerate Their OTT Strategies: AT&T is gearing up to launch DirecTV Now, a suite of three over-the-top pay-TV packages, and Time Warner now owns 10% of Hulu — which is prepping an OTT live TV service for 2017. “A deal with Time Warner could strengthen its content ownership position, which holds great value in an OTT world, particularly if AT&T could control distribution,” said Macquarie Securities analyst Amy Yong. “Content from cable nets and a film studio as well as rights to sports broadcasts and franchises (intellectual property) could help AT&T enhance its leverage against competitors.” That, Yong added, would help its competitive positioning to not only traditional rivals like Verizon, T-Mobile, and Sprint, but also players like Comcast and Netflix.

3. Time Warner Is a Comparatively Motivated Seller Without Familiar Ownership: Unlike with Viacom/CBS, 21st Century Fox, Discovery Communications, or Scripps Networks Interactive, there is “no blocking/family shareholder,” Credit Suisse research analyst Omar Sheikh wrote in a note. “Control over a leading film and TV studio, plus valuable sports and drama networks, TWX is the partner of choice if any consolidation is to take place in U.S. media in our view.”

That said, here are things that may prove thorny:

1. The Deal Would Be Pricey: No price tag has been floated, but recall that Time Warner rejected 21st Century Fox’s $80 billion bid two years ago. Buying Time Warner would require AT&T to assume considerable additional debt. Analysts assume a successful bid for Time Warner would have to top $100 per share; the stock climbed above $90 on Friday. AT&T has $7.2 billion of cash and equivalents, and expects to generate $16 billion in cash from operations in 2016. That means a deal for Time Warner would be highly leveraged, on top of AT&T’s existing $126 billion in debt — some of that from the DirecTV buy — and some analysts don’t think there’s payback in the cards. “Though there could be some industrial logic to the speculated Time Warner-AT&T combination (similar to Comcast-NBC Universal in hindsight), we believe the upfront financial benefits do not seem as readily apparent,” Barclays analysts Kannan Venkateshwar and Amir Rozwadowski wrote in a research note. “It is difficult for us to see the positive financial benefits on a standalone financial basis.”

2. Regulatory Baggage May Be High: While AT&T-Time Warner would be a vertical combo, rather than a horizontal merger (of competitors), antitrust regulators would take a hard look at any proposed deal. “The FCC and DOJ have historically highlighted concern that the vertical integration of content owners (in this case Warner Bros., Turner, and HBO) with distribution platforms (DirecTV/AT&T) may result in harmful effects for consumers,” Sheikh said. In the Comcast-NCBU transaction, the FCC imposed several long-term conditions on the combined company, designed to prevent Comcast from using the Peacock as an anticompetitive weapon. Even so, “we think D.C. has had many regrets over CMCSA/NBCU,” noted Wells Fargo Securities analyst Marci Ryvicker.

3. Benefits From AT&T Owning Time Warner May Be Negligible: The gigantic price tag required to buy Time Warner could be overkill, according to Cowen & Co. analyst Doug Creutz. One, licensing content has become more pervasive than it was a few years ago and two, “exclusivity is not necessary and in fact may not be a good use of Time Warner’s valuable content,” he wrote in a note. “It is not clear how 1+1 in this case equals something greater than two despite AT&T’s success with other large acquisitions.” To Creutz, the strategy of marrying content and distribution has generally failed (note that Time Warner divested Time Warner Cable in 2009) and that Comcast-NBCU is the exception. There are also potential “cultural integration risks,” the analyst pointed out.

Other questions that the AT&T-Time Warner merger talks raises:

Could Another Bidder Be in Play? It’s possible that a move to buy Time Warner by a large bidder (Apple?) prompted AT&T to accelerate its move to nab the media conglomerate. Sources say Rupert Murdoch and Fox are not interested in a return bid. Tech companies might be interested in Time Warner “for its scarcity value,” RBC Capital Markets analyst Steven Cahall wrote in a note. “If content companies are key acquisition targets, then TWX is unique in being both heavily focused on owned content and perhaps more importantly is a single-class equity share structure that has no familial considerations.” The latter sets it apart from FOXA, CBS, Viacom, SNI, and DISCA. That basically only leaves DIS, which might be an impossibly big deal at nearly $150 billion market cap.

Whither Jeff Bewkes? He has signed a contract to remain CEO of Time Warner through 2020. But in the event that AT&T acquires the company, Bewkes may exit the post early — and the question then would be who would oversee the Time Warner empire. Peter Chernin, head of Chernin Group, already has a relationship with AT&T via the two companies’ Otter Media joint venture for over-the-top content, and he could be a candidate to step in to oversee the Time Warner operations, either under AT&T Entertainment Group CEO John Stankey or in a newly created role.

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