One Big Question About the AT&T-Time Warner Deal

SMITH BRAIN TRUST — AT&T's proposed $85.4 billion acquisition of Time Warner could be the first of a string of similar mergers to come. So you have to wonder: Why is Wall Street giving the deal such a cold shoulder? It could be a sense that the deal won't go through, or it could be a sense of market deja vu. With Time Warner's long, but less-than-sterling record in mergers and acquisitions, investors can be forgiven for experiencing a sense that they've seen it all before.

"My first reaction?" says Richmond Mathews, a finance professor at the University of Maryland's Robert H. Smith School of Business. "Oh, no. Here we go again." Mathews teaches a financial restructuring course each semester and guides students through the 1989 deal that brought Time and Warner together, a case that led to a seminal ruling on what managers can do in the face of hostile takeover offers, and AOL's $164 billion takeover of Time Warner in 2000, a badly timed deal that is widely seen as the worst merger of all time.  

"There are two vertical deals that were already problematic involving Time and Warner," Warner says. "Now we have a third vertical deal."

Again, Mathews says, a company with downstream customers is trying to snap up content from Warner Studios, whose portfolio includes HBO, TNT and CNN. In this case, the acquirer is telecom giant AT&T, with its wireless, DirecTV and U-Verse customers.

Matthews notes that Time Warner just last year shed its own downstream assets, selling off Time Warner Cable to Charter Communications. "Why is it going to be so great this time to be vertically integrated when these other times didn't seem to work all that well?" Mathews says. 

The proposed takeover, announced Saturday, almost immediately began stoking suspicions that the marriage of AT&T's millions of wireless and pay-TV subscribers with Time Warner's collection of TV networks and movies would lead to fewer options and higher consumer prices. Politicians across the ideological spectrum — from Donald Trump, to Bernie Sanders, to Hillary Clinton — have voiced concerns about the implications of the merger, hinting the deal could face serious regulatory hurdles in Washington.

Skepticism in the share prices

That's left some investors feeling dubious about the deal's prospects even as the telecom world buzzes about the proposal, says Smith School finance professor David Kass, pointing to the stock prices of both companies.

The deal, if green-lighted, would consummate in about a year. Still, shares of Time Warner on Thursday were trading 20 percent below the implied value of AT&T's $107.50 per share cash and stock offer. In a time of ultralow interest rates and amid an equity rally that's believed to be running on fumes, a 20 percent return should be drawing considerably more heat from investors. By his own estimate, Kass says, the market is pricing in about a 50 percent likelihood of the deal reaching fruition. And that's kept trading chilly.

"If the market thought this deal was going to go through, Time Warner would be trading at about $95," he says. TWX was trading around $88 on Thursday, roughly halfway to $95 from where it was before the rumors of the deal were leaked Friday.

Nonetheless, Kass says he sees few reasons why the deal won't clear the regulatory maze. The integration is vertical — meaning the acquirer is buying a customer, not a competitor — and such deals "are rarely opposed," Kass says. However, he adds, vertical deals also "rarely prove to be beneficial for the acquiring firm's shareholders." That's because with less overlap in functions, acquirers find fewer cost-slashing opportunities after the consolidation.

Generally, just three things that can derail such a deal: Regulators, a vote from shareholders, or a change of heart from the executives, Mathews says. "The more negative the stock market's reaction to a deal, the more likely the deal will be canceled," he says, citing research published in the Journal of Finance. However, thus far, the market's reaction has been tepid, not negative.

Content Is Still King

Despite Wall Street's lack of enthusiasm for the deal, industry watchers are taking note, says Smith School marketing professor P.K. Kannan. 

"Such mergers are going to happen in one form or another," Kannan says. Mergers between access providers such as AT&T and content creators, such as Time Warner, are a key way for access providers to differentiate themselves and mine new revenue sources. "The wireless market is saturated," he says. "Now the only way it can grow is with the content it can provide."

Verizon Wireless has taken a similar path, acquiring AOL and seeking to buy Yahoo's web operations. And this week, many eyes were on entertainment behemoth Netflix, as potentially the next target for acquirers.

For content creators, meanwhile, deals with wireless companies bring access, in a portable, omnichannel, consumer-friendly way. And maybe, analysts say, at a single price, across devices.

And AT&T is already hinting about how it will price content. CEO Randall Stephenson, perhaps seeking to counter expectations of higher prices for consumers as a result of the merger, said this week AT&T would charge just $35 a month for its internet-delivered television service DirecTV Now when the service debuts on mobile later this year — a price below what analysts were anticipating.

AT&T's proposal comes amid an increasing focus on consumer option value and the growing trend of cable cord-cutters who still want quality programming, available to stream online. "We have smart TVs; we have tablets; we have smartphones; we have smartwatches," Kannan says. "Who knows what is going to come next."