Will The Latest Media Mega-Merger Find Success?

Adam Fischbaum's picture

Thursday, November 3, 2016 - 11:30am

by Adam Fischbaum

Sixteen years ago I was thinner and had more hair. I also had a front-row seat to watch what was billed at the time as "the merger of the century": AOL and Time Warner. What began as a perfect marriage of one of the best content and broadcast distribution complexes on the planet to the media distribution platform of tomorrow -- a combo that would have an initial market cap of $350 billion (unheard of at the time) -- ended in a whimpering split with both entities deeply discounted. 

After the divorce, AOL evolved from its original persona as an internet service provider to an actual, online content destination featuring sites such as the Huffington Post and MapQuest. AOL was acquired by AT&T's chief wireless rival Verizon (NYSE: VZ) in 2015. Time Warner carried on business as usual, creating a seemingly endless stream of media content and distributing it via its cable networks and movie studios.

But the more things change, the more they stay the same.

Now, as a dominant force in wireless telecom, internet, and television distribution with its recent acquisition of DIRECTV, AT&T (NYSE: T) is determined to not only control every screen we watch but what we watch on them as well. The communications behemoth has announced it is acquiring content treasure trove Time Warner (NYSE: TWX).

But is this bold move a bridge too far?

Why The Old Merger Failed
Let's go back to the AOL deal. In 2000, the internet as we knew it at the time was still in its infancy. The squeal of a dialup modem was state-of-the-art. 

However, the Tech Bubble was already overinflated and starting to burst. It seems AOL was paying too much for Time Warner: a 67% premium to its stock price for a total of $182 billion. But AOL boasted 20 million subscribers. That's 40 million eyeballs to consume Time Warner's content like CNN news or the Cartoon Network. That's only $4,500 an eyeball! A bargain in those heady times.

In 2002, with Tech-Bubble deflation in full Hindenburg, the media company of tomorrow posted a $99 billion (54% of the original value of the deal) goodwill write down. The market value of AOL-Time Warner slid from $226 billion at its peak to $20 billion at its trough, a 91% haircut for shareholders. The rest is ugly history.

Fast forward to now: One of the biggest media platforms on the planet is betting big on a similar deal. I don't know if it'll be different this time. 

But I do know that the numbers involved are much more reasonable.

Can AT&T Succeed Where AOL Failed?
AT&T is paying a 20% premium for Time Warner shares: $107.50 per share in AT&T stock and cash. Looking through the stats, it looks as if that 20% bogey is consistent across the board from earnings to price to cash flow. 

Looking at the number of eyeballs involved, AT&T currently has around 133 million wireless subscribers, or 266 million eyeballs, to consume Time Warner content. At an $85 billion acquisition price, AT&T is shelling out just $319 per eyeball, which is 96% less than AOL was prepared to pay 15 years ago. So, on the surface, it doesn't look like AT&T is overpaying.

However, the company's debt load will balloon from around $117 billion to $200 billion, pushing long-term debt-to-capitalization higher by over 35%. That should be troublesome to AT&T shareholders who are used to the generous, 5%-plus dividend yield. Will the merger jeopardize that?

Maybe. But although the company is increasing its debt load by roughly 70%, annual free cash flow will nearly double to $25 billion from $12.8 billion. Effectively, it looks like the new company (AT&T on steroids) will be able to, at least, maintain the current dividend.

Risks To Consider: The market wasn't thrilled by this announcement. While in classic fashion, the acquirer's stock went down (T shares down more than 8%) and the acquiree went up (TWX +12.5%), TWX shares are still 20% below the announced takeover price. This says that the market is more than just a little skeptical about the deal going through.

While the current regulatory environment may suggest that the deck is stacked against this merger, the primary argument against the merger that regulators might have had was settled a while back when Time Warner spun off its cable television business, which has since been gobbled up by Charter Communications (Nasdaq: CHTR). The odds of the deal being successful are better than they appear.

Action To Take: While it always pays to keep an eye on the situation, AT&T shareholders should find some comfort in the numbers. It looks like management has done its homework and has kept the metrics of this merger from getting too large. I don't see the ghost of mergers past haunting this deal. 

On a broader note, the multiscreen media platform (smartphone, television, tablet and yes, even the old school PC) that AT&T brings to the party is a far cry from AOL's vintage ISP days. It's like comparing a Formula One car to my mother-in-law's Buick sedan. There is no comparison.

Investors looking to pick up AT&T shares currently have a good opportunity with the stock trading around $36.50, a 17% discount from its 52-week high, with a trailing dividend yield of 5.3%. However, while the numbers look good, don't look for runaway earnings growth out of the gate. Things should remain steady at first, while in the long run this combination should yield higher revenues, free cash flow, and earnings, something this big takes a while to work. Be patient and enjoy getting a 5% yield for the time being.

Editor's Note: AT&T isn't the only dividend stock you should be holding...Ever wonder how the most successful investors can afford to be successful? They have a cache of dividend stocks. In fact, there's even a name for it... We call it the Dividend Advantage...​

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.