Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

AT&T CEO Randall Stephenson is no Hollywood bigwig. The Oklahoma native has spent his entire career in the far less flashy telephone business, beginning with Southwestern Bell more than 30 years ago and culminating as head of the No. 2 U.S. wireless carrier. But as the media and communications industries converge, Stephenson knows it's time for him, AT&T and its investors to step outside their comfort zone -- as risky and costly as that will be.

Over the weekend, the company announced a $108.7 billion takeover of Time Warner (or $85.4 billion excluding net debt, paid half in cash and half in stock), that gives AT&T control of HBO, CNN and TBS. Until now, AT&T has merely functioned as a conduit for such video content, via its subscription wireless-phone, internet and pay-TV services -- the last of which it expanded through last year's $67 billion takeover of DirecTV.

Shrinking Video Base
Even though AT&T is adding video customers on the DirecTV service it acquired last year, this hasn't been enough to offset subscriber losses on its own service
Source: Bloomberg

AT&T's transformation isn't coming cheap. If you were to add up the value of each piece of Time Warner, it totals about $105 a share, according to an analysis by Bloomberg Intelligence. That means at $107.50 a share, AT&T is surely paying full price. And it's valuing Time Warner at about 13 times this year's estimated Ebitda, a higher multiple than any of the big entertainment-media stocks command. It also tops comparable transactions, including when Comcast took full control of NBCUniversal in 2013.

Paying Top Dollar
It's like Time Warner demanded the highest price possible and AT&T said, "Sure, why not?"
Source: Bloomberg and Bloomberg Intelligence

The price is even more noteworthy when you consider that 21st Century Fox, one of Time Warner's closest competitors, is said to have no plans to counter AT&T's bid (it offered $85 apiece for the business in 2014). And Apple, flush with cash, approached Time Warner a few months ago but is just "monitoring" the situation, according to a Wall Street Journal report.

AT&T has left itself no room for error. The company believes it can eventually wring out $1 billion a year of cost savings -- double what some analysts figured -- despite having little overlap with Time Warner. This deal will be watched more closely than any other, not just because it's the biggest of the year and it puts AT&T in danger of a debt downgrade. It's also a test of whether the argument "but AOL Time Warner was a disaster" is an outdated one. Or will the business models and cultures of AT&T and Time Warner clash in the same way? 

Growth Dilemma
Buying DirecTV gave AT&T a short-lived revenue jolt. Without Time Warner, analysts see growth returning to the 1%-2% range as AT&T loses video subscribers and feels pressure on its wireless business
Source: Bloomberg

What we do know is that how we consume entertainment is much different today, and in just three years, the media industry could be completely reshaped. AT&T needs skin in the game to retain pricing power and some semblance of growth. The trick will be balancing proprietary content as a way of retaining subscribers and selling content to competitors to drive revenue -- a sticking point when regulators studied the Comcast-NBCUniversal merger.

So yes, there are many risks involved here -- but staying put has its dangers, too. Perhaps Stephenson deserves some credit for moving quickly to diversify, before AT&T begins really feeling the pressure of competitive unlimited data offerings from rivals T-Mobile and Sprint or loses more pay-TV subscribers in the wake of cheaper over-the-top services such as SlingTV and Netflix. Acting now also keeps it from missing out on what are some of the best content assets available (clearly others have had their eye on Time Warner -- and take HBO: It's arguably better off within AT&T given that it can afford to invest more heavily in the original content that makes it so successful). The deal will be beneficial, too, for the new DirecTV Now over-the-top service that AT&T is launching. 

Tough Audience
CNN's ratings have surged 89% this year amid coverage of the U.S. presidential election, while other Time Warner networks -- such as TruTV and Adult Swim -- have declined
Source: Nielsen data compiled by Bloomberg Intelligence analysts
Live +7, ages 18-49

Investors should also keep in mind that content companies and more diversified distributors tend to command higher valuations. Just look at the protagonists in this deal: AT&T was valued Friday at less than 7 times this year's Ebitda, but it's paying nearly double that for Time Warner. 

And while it's hard to imagine AT&T as a media conglomerate, it's not alone in making this move. Aside from Comcast, which may have its eye on T-Mobile, one of the industry's biggest dealmakers has been billionaire John Malone, who's rolling up a slew of assets and deepening the ties among his complex cluster of media businesses. His Discovery Communications took a stake in movie studio Lions Gate, also indirectly his, and Lions Gate is acquiring pay-TV provider Starz, another Malone property. Speculation is that Scripps Networks or AMC Networks could be next on his list, or that he could use Charter Communications, which bought Time Warner Cable, as an acquisition vehicle. 

Media Mash-Ups
A decade ago, industry deals centered on publishing companies. Then media M&A surged again in 2014-2015 as pay-TV providers consolidated. Is AT&T kicking off another wave, this time for content?
Source: Bloomberg

What will be key to AT&T's success is having the right people. This matters more in creative industries such as TV and movie entertainment than anywhere else. Consider the success of CBS, run by the much-esteemed Les Moonves, versus its sister company Viacom, which should be a millennial mainstay and yet is struggling worst of all amid turmoil in its top ranks. Time Warner Chairman and CEO Jeff Bewkes is staying for a transition period following the merger, but the companies haven't said how long that will be. 

If this deal gets past regulators, which I think it will, it could still take a long time to get AT&T shareholders on board with the strategic rationale. Perhaps Stephenson should dust off AT&T's old slogan: Rethink possible. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net