Monday, August 28, 2017

AT&T preps for its mega-merger with Time Warner – Part 2

Part 1 of this article covered operational metrics from AT&T's Q2 2017 financial report. This week, AT&T confirmed that its $109 billion blockbuster acquisition with Time Warner is on track and likely to close by the end of the year. Although the company did not explicitly say that regulators, including the Department of Justice and the FCC, are likely to approve the merger, one can presume that no major issues have been presented yet that could threaten the deal. As the first mega-merger to face review under the Trump Administration, it has not been exactly clear what level of objections such mergers might face, especially under a president who routinely attacks CNN (a Time Warner property) as 'fake news'. Under the Obama administration, AT&T was blocked from acquiring T-Mobile US because the combination was seen as market consolidation that would be detrimental to consumers.

Key terms of the AT&T – Time Warner combination

As a reminder, AT&T officially announced its intention to acquire Time Warner on October 22, 2016. The deal was to be structured as a stock-and-cash transaction valued at $107.50 per share, representing a transaction value of $108.7 billion. The companies said the reason for the deal is to combine Time Warner's library of content and ability to create new premium content with AT&T's extensive customer relationships, world’s largest pay TV subscriber base and scale in TV, mobile and broadband distribution. Time Warner, which was formed in 1990 through the merger of Time Inc. and Warner Communications, encompasses many premium media properties, including HBO, New Line Cinema, Turner Broadcasting System, The CW Television Network, Warner Bros., CNN, Cartoon Network, Boomerang, Adult Swim, DC Comics, Warner Bros. Animation, Castle Rock Entertainment, Cartoon Network Studios, Esporte Interativo, Hanna-Barbera Productions, Warner Bros. Interactive Entertainment. It also owns 10% of Hulu.

The basic idea driving the merger is for Time Warner to act as the content arm for AT&T, providing mobile and fixed broadband line subscribers with valuable material as part of packaged service bundle. Consumers presumably would purchase an AT&T service bundle based on the perceived quality and value of the package rather than simply the lowest price for mobile connectivity. This will allow ARPU to rise and ensure a 'stickiness' factor that goes beyond the latest mobile handset deals, currently a leading cause for subscriber churn.

As a content provider, Time Warner requires far less ongoing capital expenditures than AT&T, which must invest routinely in its infrastructure. AT&T has stated that it expects $1 billion in annual run rate cost synergies within 3 years of the deal closing due to cuts in corporate and procurement expenditures. As there is little overlap between the companies, its not clear where these savings would come from. Time Warner does maintain its corporate headquarters in high-priced Manhattan, but this is where significant content transactions are negotiated and it is unlikely to be relocated to Dallas.

Rising debt load

One outcome of a combined AT&T and Time Warner is that the investor profile will be very different. An article this week by Bloomberg points out that after the merger is completed, AT&T's net debt will rise to $182 billion. This will transform AT&T into a more leveraged conglomerate, putting much greater pressure on how management can use free cash flow from operations. Over the past few years, AT&T has been using significant amounts of cash to buy back its own shares, thus increasing shareholder value. AT&T has also been one the more generous corporations in terms share dividends, reportedly returning 70% of free cash flow last year, or about $11.8 billion, according to Bloomberg. Going forward, more cash will be needed to service the heavier debt load, so we might expect that less cash will be available for dividends or share buybacks.

Betting on bundling

For the deal to be a success, AT&T and Time Warner will have to generate some real synergy in the minds of consumers. With Net Neutrality principles no longer an area of focus for the FCC under the new chairman, Ajit Pai, AT&T will have more leeway in positioning special service packages for its subscribers. For instance, home entertainment services may be the first big use case for 5G networks starting in 2019. A mobile operator such as AT&T might launch a 4K TV package for residential consumers in certain markets. With connection speeds in the hundreds of megabits, AT&T could deliver a strong 5G TV service featuring exclusive shows from HBO or Castle Rock Entertainment, while also including in the package regular LTE smartphone connectivity for all members of a household. Such an offer would be unmatched by rivals such as Sprint and Comcast.

There is already some movement in this direction. AT&T is ready to launch a 5G video trial with DIRECTV NOW service in Austin, Texas. The trial will evaluate how fixed wireless mmWave technology handles heavy video traffic. Previously, AT&T reported that its 5G lab trials were achieving speeds up to 14 Gbit/s and latency of under 3 milliseconds.

But how is video bundling working so far for AT&T? In July 2015, AT&T completed its acquisition of DIRECTV, making it the largest pay TV provider in the U.S. with more than 26 million customers in the U.S. and millions more in Latin America, including Mexico and the Caribbean. The implied total equity value of this deal was $48.5 billion although the total transaction value was $67.1 billion, including DIRECTV's net debt.

The DIRECTV acquisition also brought exclusive, premier content, particularly live sports programming to AT&T, including exclusive pay TV rights to NFL SUNDAY TICKET, ownership of ROOT SPORTS Networks and minority stakes in the Game Show Network, MLB Network, NHL Network and the Sundance Channel. Soon after completing the merger, AT&T began offering bundles combining cellular service, satellite-TV or U-serve TV over FTTH (in certain markets). These offers have been widely promoted via TV and print advertising, in the carrier's retail stores, and in notices to AT&T's millions of mobile users.

On a regular basis since then, AT&T execs have described the merger as a 'hit', citing higher ARPU from consumers who take both services. By Q2 2016, AT&T added nearly 1 million DIRECTV subscribers. In more recent quarters, this moment appears to have stalled, perhaps because the pay TV segment is no longer growing as more cord-cutting consumers look to over-the-top (OTT) services instead of traditional satellite TV subscriptions. Operating metrics for Q2 showed a loss of DirecTV and U-verse TV subscribers in the quarter. However, AT&T’s over-the-top DirecTV Now service continues to add subscribers every quarter and now stands at 491,000 users. So, if hardware-based bundling is capex intensive and no longer growing, perhaps OTT packages are the way to go.


AT&T appointments executives ahead of merger with Time Warner



AT&T has announced a number of executive appointments in preparation for completing its acquisition of global media and entertainment company Time Warner; the transaction is currently under review by the U.S. Department of Justice and competition authorities in certain foreign countries.Effective August 1st, the following executives will assume new positions and continue to report to AT&T chairman and CEO Randall Stephenson:1.  ...



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