AT&T, Time Warner Fail To Settle Acquisition Talks With DOJ

AT&T Inc. (NYSE:T) and media giant Time Warner Inc. (NYSE:TWX) are finally heading for a battle in court against the U.S. Department of Justice (DOJ) in 2018 over their $85.4 billion big-ticket merger deal. On Nov 20, 2017, the U.S. Department of Justice (DOJ) filed a lawsuit against the telecom behemoth over its mega acquisition deal citing that the proposed deal will increase prices for rival pay-TV operators as well as subscribers. It will also act as a stumbling block for the development of online video. Recently, AT&T and DOJ again engaged in a settlement talk which failed to resolve the issue unanimously.

DOJ’s Arguments

The DOJ in its lawsuit complained that the AT&T-Time Warner merger will be harmful to American consumers. AT&T has a vast pay-TV network. As of Sep 30, 2017, total video connections were 25.083 million. Of the total, DIRECTV satellite connections tallied 20.605 million, fiber-based U-verse connections were 3.691 million and DIRECTV NOW online streaming connections were 0.787 million.

On the other hand, Time Warner's media empire includes HBO and Turner Broadcasting, which has the rights to sports telecasts. It also owns the Warner Bros. film studio and cable networks TNT, TBS and CNN. Moreover, Time Warner owns a 10% stake in Internet video provider Hulu.

Therefore, the merged entity will enjoy control over both high-quality content and distribution medium, which is likely to create room for AT&T to raise prices without investing much to offer innovative products. The DOJ has asked AT&T to either divest it DIRECTV division or Turner Broadcasting assets including CNN. However, the company denied the arguments.

AT&T’s Counter Arguments

AT&T has argued that the proposed deal is technically a vertical merger, as neither of the companies shares any overlapping business. Therefore, the deal is not going to reduce the number of competitors either from media or pay-TV or phone industry. Earlier in 2011, the DOJ permitted Comcast Corp. (NASDAQ:CMCSA) , the largest cable MSO (multi-service operator) to acquire media giant NBC Universal. Nevertheless, AT&T is looking forward to continue talks with DOJ officials to find a solution to the deal.

What Next?

AT&T will challenge the DOJ verdict in court. However, a court ruling is unlikely to come before May 2018. Notably, both the companies have resettled the closing date for the deal at Apr 20, 2018. A trial to decide the matter is set to begin on Mar 19, 2018 and run for about 15 days, according to the filing. AT&T’s growth in 2018 will largely depend on the court ruling on the Time Warner merger deal.

If the court ruling goes against AT&T, three options will be available: either scrapping the deal, divesting its DIRECTV division, or acquiring Time Warner without the Turner Broadcasting assets including CNN.

We believe that disinvestment of DIRECTV is out of question as the company is gradually promoting its satellite-based DIRECTV brand over its fiber-based U-Verse as its new pay-TV offerings. Moreover, DIRECTV NOW online streaming service is quickly gaining market traction, which recently surpassed one million subscribers.

On the other hand, disinvestment of Turner Broadcasting’s assets including CNN will prevent AT&T to derive maximum synergies. Management expects the deal to be accretive to both adjusted earnings and free cash flow, in the first year post its closure. The company is likely to achieve cost synergies of $1 billion per annum within the first three years of the merger. The company expects the deal to help in diversifying its revenue mix, lower capital expenditure and reduce regulatory restrictions.

Finally, if AT&T abandons the Time Warner deal, it will be the company’s second big ticket merger to fail after the $39 billion merger proposal with T-Mobile US Inc. (NYSE:T) that was discarded by the FCC.

On the other hand, if the court ruling on the Time Warner deal goes in AT&T’s favour, the merged entity will enjoy control over both high-quality content and distribution medium. This may enable AT&T to raise prices without investing much in innovative products. The proposed merger with Time Warner will provide AT&T a portfolio of lucrative contents. Time Warner's media empire includes HBO and Turner Broadcasting, which has the rights to sports telecasts in addition to Warner Brothers movie studio.

Price Performance of AT&T

AT&T’s shares have increased 1.4%, marginally better than the industry’s growth of 1% over the past 90 days. The company carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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