Revisiting AT&T’s Rationale for Buying Time Warner

It was way back on Oct. 22, 2016, when AT&T (NYSE: T) announced it was buying Time Warner (NYSE: TWX) for $85 billion, in a half-cash, half-stock deal. But when the U.S. Department of Justice sued to block the acquisition, the closing process soon became a legal process.

Now that AT&T and Time Warner have won pretty decisively in court, some may have forgotten why AT&T was so keen to snap up Time Warner in the first place. Do you remember the rationale for the megamerger?

1. HBO: A global subscription powerhouse

AT&T is already a huge company, offering wireless, broadband, and cable packages throughout the U.S. and Latin America. And while all these offerings are “sticky” subscription businesses, AT&T lacked a content play under the same model.

AT&T-Time Warner: Why? Image source: Getty Images.

That’s where Time Warner’s crown jewel HBO comes in. It may have lost its undisputed lead in premium content to Netflix (NASDAQ: NFLX), Amazon (NASDAQ: AMZN), and improving peers like CBS‘s (NYSE: CBS) Showtime. But HBO is still on par with any of them in terms of quality, and had 142 million subscribers — more than Netflix, Amazon Prime, or Showtime — at the end of 2017. In addition, over 88 million are overseas, in geographies AT&T might not (currently) touch.

HBO also grew revenue an impressive 7% and operating income 12% in 2017, a challenging year for media companies in general. Clearly, HBO still is a great asset to have under anyone’s corporate umbrella.

2. Sweetening the bundle

HBO could also act as a big sweetener to U.S. customers for AT&T’s broadband, cable, and wireless bundles. Typically, AT&T competes with only one other larger cable or broadband company in a given area (near me, it’s AT&T vs. Charter Communications (NASDAQ: CHTR)). AT&T could start offering either free or discounted HBO as part of its bundle, to differentiate itself from others in the space. Though there are differences in the details between these bundles, in most developed urban areas, wireless/broadband/cable offerings are fairly similar. So any way a company can stand out is valuable.

For instance, T-Mobile (NASDAQ: TMUS) is offering to pay for its customers’ Netflix subscription (the standard definition plan, $3 premium plans) when you sign up for two or more lines. T-Mobile made that agreement after the proposed AT&T-Time Warner deal, so it’s likely T-Mobile felt the need to keep up with AT&T’s packaging.

3. Data-driven advertising and content creation

One of the more interesting tidbits in AT&T’s initial merger announcement was the line that the combined company would provide “more innovation with ad-supported models that shift more cost of content creation from customers to advertisers.”

Translation: AT&T hopes to use its massive trove of customer data to more effectively target Time Warner’s advertising. It’s a new age of more precise, targeted ads than the traditional TV model offers — look no further than Facebook’s (NASDAQ: FB) doubling of revenue per daily active user in just the past few years, or the recent success of ad-tech company The Trade Desk (NASDAQ: TTD) as evidence.

If AT&T-Time Warner can garner more dollars per ad, it appears the company hopes to keep subscription prices in check for its cable bundle (or skinny DirectTV Now bundle), which could help prevent more cord-cutting.

4. Maintaining the dividend

For any company, such a large acquisition takes some serious cash, and AT&T’s already high debt load will balloon to roughly $181 billion post-acquisition. That’s potentially dangerous for a company whose dividend payout ratio is already above 90%.

However, Time Warner is one of the few properties that should generate enough cash flow to help AT&T maintain its hefty 5.8% dividend yield, a main feature of owning telecoms to begin with. Time Warner generated almost $6 billion in pre-tax income last year, and AT&T plans on generating a further $1 billion in annual synergies.

A fascinating strategy

Post-deal, AT&T hopes to be lumped in with innovators from Silicon Valley rather than stuffy old telecoms. Only time will tell, but with HBO’s global subscriber base, a more comprehensive bundle, more targeted advertising, and a sustained dividend, AT&T should at least find itself in any big-league conversation going forward.

10 stocks we like better than AT&T
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now… and AT&T wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of June 4, 2018

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Billy Duberstein owns shares of Amazon, AT&T, Charter Communications, Facebook, Netflix, The Trade Desk, Time Warner, and T-Mobile US. His clients may own shares of some of the companies mentioned. The Motley Fool owns shares of and recommends Amazon, Facebook, Netflix, and The Trade Desk. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.

You May Also Like

About the Author: Over 50 Finance