This week, the Department of Justice's case against the AT&T (T 1.52%)-Time Warner (TWX +0.00%) merger ended with resounding support for the companies.
In this episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Evan Niu walk listeners through the deal, the DOJ's opposition to it, and what comes next for everyone involved. Find out what exactly the Department of Justice claimed was so dangerous about this merger, and why those arguments fell flat; the important differences between vertical and horizontal mergers; what this decision will likely mean for future mergers-and-acquisitions activity; how this combination will affect AT&T, Time Warner, and consumers; who wins the most from this merger; and more.
A full transcript follows the video.
This video was recorded on June 15, 2018.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, June 15th, and we're talking megamerger. I'm your host, Dylan Lewis, and I'm joined on Skype by fool.com's Evan Niu. Evan, I've been out of the office for a few weeks, I've missed some big-time news. Just got back, first day back was Wednesday. I've missed quite a bit in the financial markets, huh?
Evan Niu: Yeah, quite a big news drop right when you got back.
Lewis: Yeah. It's nice to have something to talk about. Before we get into the AT&T-Time Warner deal, which has dominated headlines this week, I want to revisit something that I missed while I was gone. I didn't have the good fortune of being in town when the Washington Capitals won the Stanley Cup. Our producer, Austin Morgan, is a big-time Caps fan, and none of the hosts have given Austin a chance to talk about his experience being at the parade. So, I wanted to give him a chance to do that.
Austin Morgan: It was electric. There were so many people there. Everyone was so happy for a D.C. championship, it was a lot of fun. I went down for game five in town. It was a happy crowd. No one burned anything. A couple of pole climbings, not too bad. The parade, there was a lot of people down there.
Lewis: What was better, being in there for when they won it, or being in the city for the parade?
Morgan: I think being in there when they won it. It was an event, it was crazy. The parade was fun, but it was tough to see the parade unless you got there at 6 in the morning, which I did not. I mean, great experience all around.
Lewis: Hopefully we'll get to do it again next year.
Morgan: Back to back, T.J. Oshie.
Lewis: And hopefully, I'll be in town next year if it happens. Alright, Evan, why don't we talk about some of the financial news from the past couple of weeks? The news fairy was very kind to us, giving us some merger deals. Why don't we talk about AT&T and Time Warner?
Earlier this week, a federal judge approved AT&T's plans to buy Time Warner, and unless DoJ appeals the deal, it seems like it's going to be going through.
Niu: They announced this deal back in late 2016. Naturally, it was going to face some type of regulatory scrutiny. The Department of Justice filed suit against it to try to block them back in November of last year. This is the result of that trial. They went to trial for six weeks.
Basically, the federal judge sided with AT&T and against the U.S. government, saying the U.S. government failed to prove its case. The government was arguing that this is anti-competitive, it might hurt consumers in terms of pricing, it would make the markets for video programming and video distribution less competitive. Ultimately, the federal judge didn't buy those arguments, and they weren't able to really make a good case for them.
Lewis: As a quick refresher for the companies and the properties at play here -- AT&T, of course, the telecom giant, they also own satellite TV provider DIRECTV. Time Warner owns properties like HBO, Turner cable networks, and the Warner Brothers film and TV studios. Not so much a horizontal acquisition, which is something we'll talk about later, but more of a play to build out the portfolio of offerings for AT&T and getting into the content business a little bit.
Why don't we talk a little bit about some of the deal winners and deal losers? That might be the easiest way to break things down. I think it makes sense to start with, why did AT&T want Time Warner to begin with?
Niu: It really follows a long trend of what we've been seeing happening in the telecom space, which is, these telecom companies are increasingly wanting to buy media companies to own the content that they distribute. Certainly, the big poster boy for this was Comcast (CMCSA 12.90%) buying a big stake in NBCUniversal nearly ten years ago. It's worth noting that, back then, the Department of Justice did not try as hard as they did to block that one like they did this time, even though these two deals are very similar. It's just a telecom company trying to buy up a giant media company. That set this tone.
In the past decade, we've seen Verizon doing a lot of these media type big deals, too. I think that's just where these companies are going. Telecom, fundamentally, is a commoditized service, and they feel like if they own the underlying content, they have more of a way to differentiate themselves from their competitors. So, yeah, this is just the latest in a long string of these gigantic telecom-media mergers.
Lewis: And this is something we've seen as cord cutting has become much more prevalent. We have all of these over the top options available for consumers, and increasingly, ad money is going other than TV. It's going to digital ad spend with Facebook and Alphabet. So, I think you look at these businesses, and they're trying to build strength and presence with these types of acquisitions.
Niu: Right, exactly, that's also part of it, too. This whole landscape is changing so quickly that a lot of this is being done to keep up with how this is evolving over time. Like you said, there's all these over the top services -- Netflix, Hulu, etc. Of course, these media companies own Hulu. Over the top is a big thing, cord cutting, ad revenue is all shifting. The traditional TV business is not as great as it used to be. That's why these companies are trying these other moves to cut costs, hoping for some cost synergies, and vertically integrating other parts of the value chain, as a way to keep up with how everything is changing with the technology these days.
Lewis: Yeah. The transition in the media space and where ad dollars are going was one of the things that the federal judge pointed to a reason why this wouldn't necessarily be bad for consumers. One of the other elements of this that played a really big role in the decision was the fact that this was a vertical acquisition and not a horizontal acquisition. Evan, do you want to walk through what the difference is there?
Niu: Sure. In a horizontal merger, that's where you have a company that's basically merging with a direct competitor. A good example of this that's very relevant right now is, T-Mobile and Sprint are trying to merge, and those are two companies that are in the same space. They're huge companies, in a very oligopoly industry. There are only four national carriers. So, if they're able to merge, that's a horizontal merger, where, by definition, the combined company has a much bigger market share than they would otherwise.
That's really where there's a lot more potential for consumer harm. If you take out one of your direct competitors, you obviously have less of an incentive to compete and lower prices and all the good things that competition brings.
In a vertical merger, that's where you're basically trying to vertically integrate some other part of the value chain. In this case, AT&T and Time Warner merger do not compete with each other right now. They're in totally different parts of the market. Basically, Time Warner is a content supplier. So, that's not a situation where there's fundamentally going to be this huge potential to hurt consumers.
Lewis: And looking at this deal, we'll get into why maybe this isn't it a slam dunk for AT&T, but it feels like a pretty good win for Time Warner. They're getting scooped up, they're getting scooped up at a premium, and they are able to be a content provider within this larger business.
Niu: Right. Time Warner shareholders will end up owning about 15% of the combined company. They're a clear winner here. Any time your company is getting bought, like you said, there's a big premium involved. There's a cash and stock component to the deal, so, they get to pocket some of the cash, which takes some of the risk off the table. Then, the stock that they'll get, as well, they will get to participate in the combined company's future, both up and down, better and worse, going forward.
Lewis: Another winner from Time Warner is CEO Jeff Bewkes. This is an executive that has really been at the helm for a while at this company, and I think played a pretty big role in creating all these properties that became so valuable to AT&T. We've seen this amazing rise in prominence for HBO because of all this amazing programming that they've put out over the last couple of years. Bewkes was largely behind that. He also helped untangle Time Warner from AOL, which was a failed megamerger, [laughs] and one of the reasons why I can be kind of skeptical of these types of high-value acquisitions. It seems like Bewkes walks out of this as a pretty clear winner.
Niu: Yeah, he's going to get a nice little payday. Like you mentioned, the AOL-Time Warner deal was such a famous disaster. At this point, right now, it'll be on AT&T to execute on this acquisition and integrating it, and really seeing this vision through. I think, while on face value, they're a winner because they got what they wanted, they're also taking on a humongous amount of debt. The combined company will have something like over $180 billion in debt, because they're assuming Time Warner's debt, they're also taking out some debt to finance the cash portion of the deal. There's quite a bit of risks associated here.
And if they can't make this thing work -- again, you have this precedent of AOL-Time Warner looming as a shadow in the background -- then, that would be painful, if it doesn't work. The onus is going to be on them going forward to make it work in light of these risks that they're taking to complete this deal.
Lewis: Yeah, looking at the numbers, in non-adjusted dollars, this is the sixth-largest acquisition of the past decade. I tend to have a bias against these types of buys, because you're putting out a lot of money. In this case, they're taking on more debt to make this happen, and AT&T is already a fairly levered company. They already have quite a bit of debt on their books, long-term debt particularly. With a lot of these mergers, you see this idea of synergies coming up, and that being one of the main reasons they site. There's going to be cost savings, there's a lot of overlap in these businesses, and they're going to be able to realize some cost savings there. They are not citing a ton of that in this deal. I think it's about a $1 billion run rate within the first three years of the deal closing. So, that is not as much of a concern for me here with AT&T.
I will say, they're getting performing assets with Time Warner. These are cable networks that are doing pretty well. Like I said, HBO seems to be crushing it right now. So, less of a concern than it normally would be, but it's on AT&T to make this work, and this is a company that already has quite a bit of debt on the books. I think, with the combined business, their debt load is going to be roughly half of their market cap.
Niu: [laughs] Yeah, it's going to be quite a bit.
Lewis: [laughs] One other winner here from this deal, I think, is basically any other company that wants to go shopping in the foreseeable future, because there was a lot of skepticism as to whether this deal would go through.
Niu: Right. There also has been some concern that maybe this was politically motivated, because President Trump has a grudge against CNN, which is owned by Time Warner. I think a lot of companies that have these M&A deals or offers in the pipeline were waiting for this decision. Literally immediately, we saw earlier this week, as soon as this decision was announced, Comcast moved forward. Reportedly, they had been waiting, they had this bid for Twenty-First Century Fox that would compete with what Disney's offering. They reportedly had this bid just waiting. And as soon as this news comes out, the day after, they announced this $65 billion offer, which is 19-20% greater than what Disney's offering. That's certainly good news for 21st Century Fox. Yeah, just another big media deal.
Lewis: Yeah. If you look at this deal and Comcast's previous deal for NBCUniversal, the precedent there is pretty strong that something like that would be pushed through by regulators, that they wouldn't have any problem with, because, as you mentioned, it's vertical. It's not quite horizontal, though. With other media properties under the umbrella, maybe it gets a little bit tougher for Comcast. You mentioned the Sprint and T-Mobile deal. I don't know that that's going to be a breeze for them, because it is a horizontal merger.
Niu: Right. I still don't think that T-Mobile-Sprint has a great chance of getting approved because it's horizontal. The big thing is that vertical mergers actually have more potential to help consumers, because, to the extent that these companies can get some cost savings, if these things go through, the company can choose to pass along some of that cost savings along to consumers in the form of lower prices. Or, they keep it for themselves, or some combination of both. But, fundamentally, regulators aren't really as concerned with vertical mergers as much as they are concerned with horizontal mergers.
Lewis: We're going to talk a little bit about the way regulators approached this case, and where they fell short in making some arguments, and why DoJ is kind of a loser in this instance.
We mentioned, Evan, that this is a bit of a failure by regulators or the DoJ. It ultimately came down to the fact that judge Richard Leon ruled the Department did not meet its burden of proof for the case. Why don't we talk about some of the arguments that they were trying to make, and why, frankly, they didn't really seem to stick?
Niu: They didn't really have a strong case to begin with. Remember, the Department of Justice was the one that brought the suit against AT&T, so AT&T is basically the defendant here. That puts it on the Department of Justice to prove, make a pretty strong case and argument for why this would hurt the market, the competitiveness in the market, which ultimately would hurt consumers.
They had two big, overarching arguments. One is that it would hurt these third-party distributors, including these new, nascent over the top services that have been coming up over the years. But, that didn't really make sense, because AT&T has its own over the top service with DirecTV Now. Again, it's not like they're trying to marginalize these services. They're trying to adapt to embrace these services. The Department of Justice was basically saying, "This deal will hurt competition, it will hurt innovation." But that just doesn't make any sense. [laughs]
Lewis: The DoJ also made this argument about HBO, this quizzical one about how, with HBO under AT&T's property, they could limit the scope of HBO's use, they could prevent other people from carrying it. That's something that would hurt the money that HBO would be able to bring in for them via fees. So, it was this very tangled argument that the DoJ was trying to make.
Niu: Exactly. The idea is that, once AT&T owns HBO, which is a hugely popular service, like you mentioned, maybe they'll use it as a way to withhold it, as a way to strategically hurt other companies, other distributors.
But HBO wants to sell as much of their service as possible. This is a subscription-based business. They don't run ads. So, why would you artificially limit who you sell to and hurt yourself in the process? It just doesn't make any sense. In the testimony, HBO's Chief Revenue Office, Simon Sutton, said, "Our business relies on affiliates supporting us. If we don't do that, then our business is destroyed," something along those lines. It's silly to think that they would voluntarily crush their own business just to ... prove a point? To be different? I don't know, there's not really a good reason. They have no incentive to do this.
Lewis: The Comcast-NBCUniversal deal came up quite a bit in this case, because it is seen as a very direct precedent for what regulators might expect with activity once it's under that umbrella. I think I remember one executive saying that Comcast has no part of the negotiations that NBC makes with other companies. It's unclear if AT&T is going to do the same thing. But, the idea there is that these are somewhat separate entities.
That said, there's a lot of value in AT&T having all of these content companies within there. I think that it's something they could choose to bundle very well and use as a draw for a lot of, whether it's their wireless business, their DIRECTV businesses, there's a lot of natural stuff they could do there. I've also seen some arguments that, on the data side, they can get super targeted with what they're doing related to content, and that it might be something that they wind up pursuing that way.
Niu: Right. There's definitely a lot of angles in how they can make it work. But I think this does make a lot of sense in the context of what we've been talking about, which is, all these telecom companies want to own the media, particularly for these wireless carriers, because they also want to try to bundle it with these data plans. Mobile video is going to be a huge revenue driver for all these cell carriers going forward. If they own that service, too, that's just the best of both worlds for a wireless carrier.
Lewis: As for the impact for consumers, there was some testimony around this, and some ball-parking going on, to kind of get a feel for the worst-case scenario for the hit consumers might have with all Time Warner's properties under AT&T.
The government had this star witness, Carl Shapiro, who's an economist. He ball-parked that U.S. consumers could wind up paying just under an additional $600 million by 2021 if the merger was approved. Someone did some follow-up analysis on that, and it looks like it would wind up being a little more than $5 per cable customer per year -- which, when put in those terms, is actually really not a ton of money for the size of this overall merger.
Niu: Right. And that's only if AT&T chooses to try to go that route of increasing pricing or anything like that. That's where you have to take these companies words for what they say they're going to do, and what they actually follow up and end up doing. That's where we just have to wait and see.
Lewis: I will say, I'm generally a skeptic of companies taking any cost synergies that they realize and passing them along to customers. I don't think that you see that all that often. I think what you see instead is, prices stay the same and margins expand. So, I don't know that this is something that is truly altruistic in any way by AT&T. But it seems to me like, like it or not, it's happening.
I don't know that the impact to consumers is going to be all that strong, at least for the next couple of years. Maybe seven or eight years out, once some existing deals lapse, then we might start to see more of it felt.
Niu: Right, exactly. Certainly, I don't think these companies are going to voluntarily, generously give money back for no reason. [laughs] But, I think the bigger picture is that competition is not being hurt. So long as there's still robust competition in the marketplace, then what's more likely to happen is that AT&T will respond to competitive pressures from other companies that are offering better prices, and that's typically going to be more of a catalyst for why prices might come down. But, if they can at least save some costs on the back end, that gives them the room to at least be able to do that in response later on.
So, yeah, I think that, going forward, there's still plenty of competition in programming and distribution on the video side. That's why I think the suit failed, because of those reasons. They didn't really prove that competition was going to suffer from this.
Lewis: I am not an AT&T shareholder. I don't think you're an AT&T shareholder, Evan. Do you think that they're better off with Time Warner under them?
Niu: I'm not really interested in investing in this space in general. [laughs] Just because these companies are so huge and massive, and they're these legacy, old-school companies. I tend to stay away from those types of companies. I'm more interested in more exciting tech companies that are more looking toward the future, where these things are going to go, like Netflix, for example, which I do have shares of. I do not have shares of AT&T, and I'm not interested. [laughs] But this certainly is going to change the landscape a little bit.
Lewis: At best, it builds out their offering. I don't think that makes them all that different of a business. I think they are still going to be a staid telecom business, much like Verizon is, where you collect your dividend yield, and as long as that continues to pay out, I don't know that the price is going to move all that much and that you'll enjoy a lot of share price appreciation.
Anything else on the acquisition, on the DoJ, on hockey, before I let you go?
Niu: No, I think we're OK. [laughs]
Lewis: Alright. Listeners, that does it for this episode of Industry Focus. If you have any questions, or if you want to reach out and say hey, you can shoot us an email [email protected], or you can tweet us at @MFIndustryFocus. If you're looking for more of our stuff, you can subscribe on iTunes or check out The Fool's family of shows over at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass. For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!
