July 22, 2014

In past blog posts we have written of the way M&A is being used to acquire enormous scale in the inter-related worlds of U.S. media content and delivery. The creators of content and those that own the delivery systems (cablecos, telcos) both view scale as a means of securing advantage over the other “side”: owning more pipes means higher access charges (the rationale of Comcast buying Time Warner Cable) whilst owning the most desirable content provides the ability to deny access and thereby secure enhanced pricing for content.  At the same time both sides warily keep an eye on “over the top” providers of content such as Netflix and YouTube: firms that have the potential to use the internet to fundamentally disrupt a world of channels and networks, at least as we know them. (Interestingly, at the time of writing Netflix reported that it had surpassed the 50 million subscriber mark worldwide.)

The media columnist of the New York Times found an industry source able to describe this rather more succinctly: “ I talked to the head of one company that creates television and movies, who expressed a common sentiment “When Comcast decided to get bigger,” he said, “we all had to ask ourselves, Are we big enough? We all have to think about getting bigger.”

Time Warner Inc. (TWX – NYSE) has – deja vu 2000 – become some combination of bellweather and battleground in this regard.

Having recently sold off it its cable assets (see our blog post) as well as America Online, it succeeded in unwinding one of the great diversified media bundling stories of all time: AOL’s purchase of Time Warner in January 2000. That deal –  one of the high points of the tech/media/telecom boom of that era – was an attempt to bundle together both content and delivery. In its new, more focused (but still large) incarnation Time Warner is a focus of attempts to bundle scale in one domain.

Very much apropos of this Messrs. Marc Andreessen (the well-known venture capitalist) and Mr Jim Barksdale (former CEO of Netscape) recently gave an interview to Harvard Business Review in which they looked at issues of bundling, scale and strategy through the lens of Netscape’s IPO. They described how, at the end of a roadshow presentation at London’s Savoy Hotel, Mr Barksdale was asked “how do you know if Microsoft won’t just bundle a browser into their product” and he responded rather laconically “Well gentlemen, there’s only two ways I know of to make money, bundling and unbundling”. His somewhat perplexed audience then watched him rush out to catch a flight.

Their point was that business is a tension between new entrants using technology to disaggregate the way a service is provided and then, once they have achieved scale, recreating in some form the business they supplanted by adding assets, features or new products. Google, for example, unbundled search only to start adding on many more features and capabilities once it had come to dominate the nexus of search and advertising. The unwritten part of this is that the giant bundling deals sometimes destroy a great deal of value as they recreate mass and inflexibility that opened doors new entrants in the first place. Put another way, diversified bundles or scale bundles come together until they tip over from their own weight (or until consumers start demanding piece parts).

And so to the interest of Mr Rupert Murdoch, the successful and controversial media mogul, in Time Warner. Using his 21st Century Fox company he proposed an almost $80 billion acquisition to the board of Time Warner. From one point of view it is easy to see why: Time Warner controls CNN, HBO sports assets and much else. Marrying this to 21st Century Fox would be capstone to a truly remarkable career.

Yet Time Warner is less enthusiastic about a deal than it was when AOL came calling in 2000. Having rebuffed Mr Murdoch its board voted to amend by-laws that prevent a meeting being called by shareholders that collectively own 15% of the shares outstanding.The board cited the “significant risk and uncertainty” in the Murdoch bid and raised questions as to 21st Century Fox’s ability to govern and manage the entity that would result from a deal. This change makes it vastly more difficult for Mr Murdoch to convene a special meeting.  The reaction from the head of corporate governance at Calpers, the large Californian pension fund, was robust: “…corporate governance is not there for the convenience of management… but for the protection of shareholders…”. This is an odd statement given that the contemplated bid is apparently made up of cash and shares, and those shares would be in a company controlled by an 83 year old media mogul through the mechanism of multiple voting shares.

With the intial approach seen off , and Mr Murdoch having a history of consistently returning with sweetened offers, Time Warner could find itself occupying both the #1 and #2 slots of largest media deals of all times. (At the time of writing TWX’s enterprise value had risen to $93 billion on bid speculation.) The second Time Warner deal could prove as financially underwhelming as the first…


18 July 2014 media deals


From a strategic point of view Time Warner + 21st Century Fox would certainly have negotiating heft with cable companies and telcos. The combined entity would (even after the proposed sale of CNN) own HBO, Warner Bros., 20th Century Fox, Fox, Fox News, FX, TNT, TBS and broadcast rights for both types of football (soccer and the NFL), professional and college basketball and Major League Baseball (amongst other things).

This should allow for an ability to resist attempts by distribution networks to extract higher carriage fees. Biggness has its virtues in this context, though (as we will discuss) the very scale of this may create regulatory risk and/or a customer revolt.

Yet what of the financial aspects of the deal?

Mr Murdoch paid $5 billion for Dow Jones, citing the appeal of the Wall Street journal as both a platform and a challenger to the New York Times.  From a strategic point of view this may be correct, but he has subsequently taken a $3 billion writeoff on the deal. Similarly his purchase of MySpace for $580 million (at the time it was the challenger to Facebook) resulted in years of operating losses be followed by a sale of this asset for a mere $35 million.

TWX shares are currently trading at an enterprise value of almost 12x 2015 EBITDA; it is also already carrying $20 billion of debt (2.5x EBITDA). 21st Century Fox also trades at 12x 2015 EBITDA and carries $19 billion of debt. Factoring in some sort of premium from current levels would produce a level of indebtedness (almost $65 billion) supported by ~$13 billion of pre-synergy EBITDA. Even after $1 billion of synergies – an amount discussed by 21st Century Fox –  this would still be considered aggressive, even in the media sector. (That said, JPMorgan and Goldman Sachs have committed to a $25 billion bridge loan, which they will presumably feel confident about syndicating in the event the deal goes ahead).

Then there is regulatory risk to consider. To date the FCC has been strangely quiet in the face of the enormous deals. The Comcast/Time Warner Cable deal did not send regulatory alarm bells ringing. Nor did Amazon’s war with Hachette, which has seen the former block Hachette’s books from its now dominant distribution channel. Nor did AT&T’s move to buy satellite broadcaster DirecTV. This quiescence may evolve as and when media behemoths decide to collaborate instead of compete: “we’ll charge a lot for our pipe and bundle all your premium content together – the consumer will pay more because they have no choice”. This may work for a time, but at some point regulators may seek to break up some of these behmeoths, or politicans may respond to consumer outrage and precipitate the regulators into action.

“Biggness” may be an alluring strategy ye it is is unclear if it necessarily creates value.