AT&T's proposed takeover of Time Warner raises two big questions: will the deal obtain regulatory approval and why do they want to merge? While regulators are likely to clear the acquisition, the chances of success appear smaller. It is far from clear the motivation for the merger or how either will do better in the merged company than on their own.
Advertising
AT&T is a regional fixed provider and national mobile operator in the US, and its focus is increasingly on mobile and developing new forms of advertising. This mirrors a similar strategy at its main rival Verizon, which has developed the mobile video service go90. Verizon is using technology obtained with the takeover of AOL and if successful, Yahoo. It is far still from a clear success.
On the fixed market, Comcast is AT&T's biggest rival and this is also driving AT&T's plans. Comcast, a cable operator, earlier bought NBC Universal, a broadcaster and production studio, as so too AT&T is now expanding with Time Warner. While the Comcast takeover of NBCU was no failure, it hasn't led to any major growth spurt either.
The pivot to advertising is surprising, given it's a market where telecom operators have had little role to date. If AT&T's plan works, it can compete directly with Verizon, as well as bigger players like Facebook and Google. Whether this will work is questionable. AT&T is full of talk of innovation, but innovation in the telecom world is limited to clever packaging and pricing of services. Innovation happens even less at companies like Time Warner. For true innovation, you need to be somewhere like Silicon Valley.
Clearance
The merger of Comcast and NBCU points to AT&T and Time Warner also securing regulatory approval. The companies are largely complementary, and the merger will not have a major impact on market shares. Market dominance can only be shown if markets are defined differently than under current regulations.
Comcast did face certain conditions for the takeover of NBCU, but as AT&T noted, these were mainly to do with net neutrality and OTT delivery. Net neutrality is now enshrined in law in the US, and it's questionable whether the OTT market (Netflix, Amazon, YouTube) still needs any protection. Time Warner does have a 10 percent stake in Hulu, and AT&T is planning to launch soon its own OTT service called DirecTV Now.
If the government does block the deal, Time Warner would receive USD 500 million as a break-up fee. If Time Warner accepts a competing bid, AT&T would receive USD 1.7 billion as compensation.
Vertical integration
The takeover is a form of vertical integration, and this raises the most questions about the logic of the merger. Without a clear to answer these, it's a very risky deal on which to spend USD 85 billion. From a pure financial perspective, the question is whether AT&T can expect a good return on its investment. A requirement for this is that Time Warner performs better than it already does. Other issues:
- Is an acquisition needed? Content can also be acquired under licences.
- Can AT&T increase its market share (in mobile) using the content from Time Warner in order to earn back the costs of the takeover?
- Will AT&T favour its own distribution channels (IPTV, satellite TV through DirecTV, mobile video) for Time Warner's content? Will it create unique content or will customers be offered discounts?
- Will Time Warner increase the cost of its content for other distribution channels? Or even offer some content exclusively through AT&T?
Telecom companies like vertical integration, something they're already familiar with from combining networks and services. There are few places where structural separation has occurred (Australia, New Zealand, Singapore) or wholesale-only challengers have emerged (CityFibre, HKBN, CIF) as major players. The telco's urge to take control also of content (production, distribution, aggregation) is understandable.
However, vertical integration also comes with a big disadvantage. It combines two activities with very different profiles and requiring different competences. The financial risk and capital intensity also vary. This strengthens the argument to keep network and services, and services and content, separate. A good example from another sector is the recent separation of PayPal (payments processing) and eBay (e-commerce). Separate from eBay, PayPal can highlight its independence and expand its wings to attract new customers. Investors are also better served by a company with a clear identity and focus.
More to come?
Will the AT&T-Time Warner find any followers? Other telecom operators could start looking at content players, such as the remaining 'majors' (Walt Disney, 21st Century Fox), broadcasters (Discovery, Viacom, CBS etc), or production studios (e.g. EndemolShine). If AT&T is successful, others will likely try their luck with the same strategy in order to keep up. Mobile- and fixed-only operators have followed a similar path, in order to keep up with the bundling taking over the market. Whether that's a sensible move or merely herd behaviour we leave to the side.
For the moment we expect AT&T/Time Warner (revenues of USD 147 billion and USD 28 billion respectively in 2015) to remain the exception rather the rule. All the major telecom operators are already investing in content to some extent, but a risky merger is likely a step too far for most.
