AT&T-Time Warner: Wall Street Not Buying Vertical Integration

Analysts question strategy behind companies' plan for massive combination
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The strategy that AT&T is betting $86 billion on—that combining its distribution with Time Warner’s content is a winner—has doubters on Wall Street.

Having already bought DirecTV to add video to its mobile and telco businesses, AT&T reached a deal to acquire Time Warner, whose assets include the content-creating know-how of HBO and Warner Bros.

The model appears similar in some ways to what Comcast did by acquiring NBCUniversal, becoming not just big but controlling both distribution and programming.

It is also a reversal for Time Warner, which shed Time Warner Cable on its way to focusing on premium content production at a time when traditional pay TV is coming under pressure from new digital and mobile business models.

The stocks of smaller programmers like Discovery Communications, AMC Networks and Scripps Networks Interactive rose Friday on the prospects that AT&T-Time Warner marked the beginning of a new wave of consolidation.

But some analysts are saying hold your horses.

“Although we believe there are merits to vertical consolidation… we are not convinced that AT&T paying an 11-12X [multiple] for TV and film content reflects tremendous industrial logic,” said Tom Eagan of Telsey Advisory Group.

Looking at Comcast, Eagan says the benefits of having NBCU under the same corporate roof are hard to quantify. He notes that Comcast says Universal films do better in the Comcast footprint and that having stacking rights to NBCU programming bolstered Comcast’s X1 operating systems.

“But to us, it’s the access to DirecTV content contract that will enable any AT&T streaming services to become financially, and therefore, operationally successful.”

Pivotal Research’s Brian Wieser said that AT&T and Time Warner getting together wasn’t surprising. “However, the price is exceptional considering our prior price target and the limited financial and strategic benefits from the transaction.”

"The logic of vertical integration in media and distribution is relatively clear. The practice isn't," said Michael Nathanson of MoffettNathanson Research. "Even if one decided it would be a good idea to try to keep content exclusive," the FCC's program access and network neutrality rules essentially make that impossible to execute.

Todd Juenger of Sanford C. Bernstein summarized AT&T's strategy as stemming from the idea that “eventually there will be competition among broadband providers and owning exclusive content will be one way for them to differentiate themselves.”

But Juenger said AT&T is paying a high price. HBO would lose value if it were available only to the DirecTV subscribers, for example.

“They would never admit it (or maybe even be conscious of it) but probably the more pragmatic logic for the deal is: Comcast did it, Liberty is doing it. So AT&T must do it, too,” Juenger said.

When Comcast finally got approval for buying NBCU, many of NBCU’s business were struggling, especially the NBCU broadcast network. Comcast replaced many executives on NBCU’s management team in order to create a more collaborative culture. Comcast was able to do that partly because it had Steve Burke, who had previously been with ABC and has proved adept at managing corporate transitions.

It is unclear which Time Warner managers would stay in place following a takeover by AT&T, if approved.

AT&T has already felt the need to issue a statement about how it would manage CNN, the news network owned by Time Warner.

“Our intent is to operate Time Warner as it operates today, with autonomy in its divisions, including the world-class creative talent and journalists that make Time Warner a leader in entertainment and news,” AT&T CEO Randall Stephenson said. “CNN is an American symbol of independent journalism and First Amendment free speech. My board and I are clear—CNN will remain completely independent from an editorial perspective.”

Analyst Rich Greenfield, who believes that legacy media companies and the traditional pay-TV business are headed for extinction like the dinosaurs, said that Time Warner CEO Jeff Bewkes should be given credit for selling at the right time or at least before it’s too late.

“While most media moguls are focused on running their companies until they are six feet under (HBO pun intended), we believe Bewkes will end up being remembered as the smartest CEO in sector—knowing when to sell and not overstaying his welcome to maximize value for shareholders,” Greenfield said.

“Worth remembering, this is not the first time Time Warner has been sold. The first was the ill-timed/executed AOL deal back in January 2000. Not long after, Bewkes worked to undo the vertically and horizontally integrated behemoth, having successfully sold/spun-off Warner Music, AOL, Time Warner Cable and Time Warner’s publishing assets in recent years. Now it appears he has sold the last remaining assets HBO, Turner and Warner Bros to AT&T.”

The traditional TV business has been under stress.

Ratings have been declining as more networks move into the original programming business. The proliferation of shows makes it harder for hits to break out and have decimated the value of reruns.

Add to that competition from streaming services ranging from Netflix to YouTube, which are particularly attractive to young viewers and have created a generation of cord-nevers—people who don’t see the value in a big-bundle, pay-TV subscription.

The number of pay-TV subscribers has been shrinking at a rate of 1% to 2% per year. And for many individual channels, the decline has been sharper as distributors reduce the number of channels they include in their bundles and consumers downgrade to cheaper tiers with fewer networks.

Streaming has opened the door for new cable TV-like services to be offered over the internet and new offerings are springing up. Dish Network’s Sling TV and Sony’s PlayStation Vue have launched but have had trouble cracking a million subs. On the way are live channel services from Google, which recently reached a deal with CBS and Hulu, which plans a first-quarter launch, and AT&T itself, which has been in negotiation with programmers to launch DirecTV Now with 100 channels.

The direct access to consumers that streaming subscription services offer is something Greenfield noted that Disney CEO Bob Iger said was important during a recent investor conference.

“Iger’s comments led investors to immediately wonder what Disney was going to buy to marry great content with direct access to consumers, meaning distribution—most have wondered whether Disney was bold enough to buy Netflix,” Greenfield said in a note. “While Disney ponders what to buy to fix its access to the consumer problem, Time Warner appears to have taken the opposite approach by selling itself to AT&T.”

Media stocks rose after the reports of AT&T’s bid for Time Warner surfaced. But Greenfield thinks they should be heading in the opposite direction.

“Time Warner’s sale is signaling impending danger for all. AT&T is not buying Time Warner for its basic cable networks. AT&T is buying Time Warner to get at its content creation engines Warner Bros and HBO, with HBO one of the only legacy media assets to establish a direct-to-consumer business (HBO Now),” Greenfield said.

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