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Is Comcast's Time Warner Cable Acquisition in Jeopardy?

By Jamal Carnette, CFA - Oct 29, 2014 at 8:30AM

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Probably not, but here's how you should feel about it if you are a subscriber or an investor.

Source: Comcast

Although we haven't heard from the Federal Communications Commission and the U.S. Department of Justice, very few individual analysts think Comcast's (CMCSA 2.68%) proposed acquisition of Time Warner Cable (NYSE: TWC) is in danger of not being approved. Between an FCC that's a revolving door of industry lobbyists and a world in which cable TV isn't as important to disseminate news and entertainment as it was even a decade ago, most analysts agree the deal will eventually be approved.

However, according to media analyst Craig Moffett, the overall stock market appears to be more bearish on the acquisition than individual analysts. The spread been the two companies share prices swelled to 8%, downgrading the deal to a 75% chance of FCC and DOJ approval according to Moffett. So, should subscribers and investors be elated or concerned by the bearish overtone of the stock market?

Subscribers probably won't experience substantive rate increases as a result of this deal
On the surface, it would make sense for subscribers to root for the deal to fail. Mergers and acquisitions generally limit choice (read: supply) and as we know from the remedial supply demand equation that less supply generally raises price when demand doesn't change. Comcast paid an acquisition premium of roughly 17% to buy Time Warner Cable, if the proposed synergies do not materialize (and generally many do not), management needs to raise prices to justify the acquisition.

However, cable is a victim of earlier successes when it comes to supply. The reason for this is that Time Warner Cable and Comcast generally don't compete in the same geographies due to the unholy alliance of government and oligopolistic gentlemen's agreements to establish geographical cable monopolies. In addition, the growth of other pay-TV options: satellite-based programming (DirecTV and Dish) and wireless companies turned pay-TV providers (AT&T and Verizon) make cable's dominance less important to the pay-TV market overall. So although cable will become very concentrated, consumers will still have choice.

Note that I stated cable prices will not increase substantially as a result of this deal. Cable has increased roughly 6% per year since 1998 and will likely continue to do so. The reason for this is increased programming costs (no monopolistic pricing) and if you're an investor here's the real reason to root for this deal.

Investors should root for the deal
While many are focusing on the revenue side of the equation for the post-merger company, the real reason for the merger appears to be expense management. And to its credit, merging appears to be the best way for Comcast and Time Warner Cable to add value for its shareholders. Considering the FCC themselves acknowledged the cost of programming for a large part for cable price increases, Comcast and Time Warner Cable have the benefit of sympathetic ears when it argues the merger will lower programming costs.

The reason why is Comcast and Time Warner would have roughly one-third of all pay-TV subscribers as a combined entity. This allows Comcast and Time Warner a larger measure of monopsony power -- essentially monopoly power as a buyer -- to better negotiate content fees with cable channels that have been exploding.

As an example, a recent ESPN/TNT NBA deal is nearly three times the previous contract price. That will eventually make its way to consumers in the form of higher bills. In the event the Comcast and Time Warner Cable are a single entity, they can better negotiate programming costs and fees by ESPN's Disney and Time Warner's TNT rather than competing against each other.

Final thoughts
As an investor, you would be foolish to not want the Comcast/Time Warner acquisition to go through. And although the market appears to be hedging its bets, it's a pretty good chance the FCC and DOJ will sign off on the merger. The larger entity will be better equipped to negotiate programming costs with channels.

As a subscriber, the result of this acquisition is less important than most think. However, that doesn't mean that pay-TV providers aren't starting to pay attention to changing demands. Last year pay-TV experienced its first every year-over-year subscriber drop as a result of the powerful trend of cord cutting. And many of those still with pay-TV are looking a smaller, less-expensive packages with an emphasis on Internet service rather than TV. If pay-TV doesn't adjust to this trend by adding more value, the result of this merger is akin to rearranging deck chairs on the Titanic.

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