The media has gone wild with 21st Century Fox's (NASDAQ:FOX) $80 billion bid for Time Warner (NYSE:TWX). Time Warner rejected the bid, but a person close to the deal stated that the company would consider an offer of over $100 per share (a 25% premium to the current offer). Even at this price, a takeover would be beneficial to the companies, which are both struggling with what seems to be a dwindling audience and decreasing bargaining power.
Cable-Cutting Could Cut These Companies' Relevance
Both 21st Century Fox and Time Warner derive a significant portion of their revenues from their cable channel networks and broadcasting. Unfortunately, services that completely cut out the cable provider and deliver content straight to the consumer, including the Apple TV, Fire TV, Roku, and Google Chromecast are becoming increasingly popular. In addition, streaming services such as Netflix and Hulu are starting to catch on as well. This is very bad news for these traditional media companies' businesses, as these technological disruptors are stealing their business. This graph explains it all:
The number of cable subscribers has been steadily declining for years, and the trend shows no signs of slowing down. As the number of subscribers decrease, so does the audience for these companies' extensive cable network assets, which in turn means decreased revenue. In addition, both are losing bargaining power as more content distributors come into play as a result of technological disruption. This is leading to decreased margins on already decreasing revenue in their cable segments (for example, 21st Century Fox's gross margin has dropped from 37.9% to 33.4% in the past two years).
A Takeover Would Give These Companies More Time to Solve Their Cable Issues
An acquisition would combine these companies cable networks, which currently provide the bulk of their revenue. A joint company would have more bargaining power with other content providers, sports leagues, etc. It would also have more pricing power in selling its own content to streaming services and as over-the-top content to users of Internet TV devices such as Apple TV, Fire TV, etc. While this added bargaining power will by no means solve these companies' cable woes, it will at least give them some breathing room while they try to transition to a more Internet-friendly business model (as more viewers cut cable, it is essential that content is distributed over-the-top and streamed through the Internet rather than just through cable to maintain viewership; even the best content will lose viewership if it is only distributed through cable).
Larger Company = More Opportunities to Invest in High-Quality Content
Content is king. Producing more high-quality content is one of the few ways these companies can overcome their dwindling cable audience. This is because high-quality content can be sold and distributed anywhere, including to streaming services, Internet TV services, etc. This way, these companies can benefit from the rise of these cable-cutting services, rather than competing with them. Netflix adapted this model of content creation, and it turned out very profitable for them.
With more assets to invest as a result of the acquisition, these companies would likely be more successful at creating high-quality content than they would on their own. If Netflix, with much fewer resources, could successfully create high-quality content, the chance that the Time Warner-Fox combination could create content that would catch on is very high. Once they are able to do this, and there exists significant demand for their content, the possibilities are endless.
The Foolish Conclusion
Even though Time Warner CEO Jeff Bewkes continues to talk about his company's strategic plans being superior to anything 21st Century Fox can offer, the facts point the other way. Both companies are suffering from the same problems, including a dwindling audience (for example, both CNN [owned by TimeWarner] and Fox News, two major channels for the networks, lost at least 1 million viewers within the last year), a decrease in bargaining power, and ultimately, a threat to their relevance in the media industry. As a joint company, they would have better pricing power and more opportunities to invest in high-quality content, thereby increasing their chances of long-term profitability. Time Warner would be wise to look reality in the eyes and seriously consider Fox's offer-it may just be both companies' only way out.
Nihar Sheth has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.