Playing M&A can be dicey, and investors got a harsh lesson in this today, as seen with the 11% drop in Time Warner (TWX) stock.
If anything, Wall Street thought that 21st Century Fox’s (FOXA) Rupert Murdoch was going to pump up his bid for the media operator, say to $90 or $95 per share (the initial offer was for $85 per share or roughly $80 billion). But instead he suddenly walked away from the deal, and now it looks like he may never come back.
Yet even with all the drama, there may still be a good opportunity with TWX stock.
Now it’s true that a combo of Fox and TWX would have been powerful. After all, there was a potential to create a true rival to Disney’s (DIS) ESPN. Fox has lucrative contracts with the NFL, MLB and Nascar while TWX has deals with the NBA, college basketball and PGA.
For the most part, major advertisers continue to pay substantial amounts for live sports events because there usually is little commercial-skipping. But there are also opportunities for better engagement, such as with the “second screen” phenomena of Twitter (TWTR) and Facebook (FB).
But perhaps the biggest play with a TWX-Fox merger was the idea of building a Netflix (NFLX) killer. At the heart of this would be Time Warner’s HBO, which has more than 28 million paid subscribers and has a long history of creating standout content like Game of Thrones and True Detective.
A merger would also provide some leverage with cable operators, which have been focused on dealmaking. Two recent examples of this include Comcast’s (CMCSA) $45 billion deal for Time Warner Cable (TWC) and AT&T’s (T) $48.5 bid for DirecTV (DTV). But there is also the rising power of new distribution platforms like Netflix, Amazon (AMZN) Prime and perhaps even Apple (AAPL).
So why on Earth did TWX say “no” to the deal? Perhaps part of the reason is the inevitable complications of getting regulatory authority. And even if a deal got approval, the process would have been a prolonged distraction.
But Time Warner also has a bright future as an independent company. Keep in mind that the company has been doing the heavy lifting of streamlining operations. Just look at the spinoffs of assets like AOL (AOL), Time Warner Cable and Time (TIME). At the same time, TWX has been focused on share buybacks and dividend increases. The current yield is a decent 1.9%.
And yes, TWX continues to have a winning hand with its movie studio. Some of the recent hit films include Gravity (which won multiple Oscars) The LEGO Movie and The Hobbit: Desolation of Smaug. Granted, the company still has work to do as TNT and CNN continue to lag. But TWX is certainly making the necessary investments to turn things around.
In fact, TWX reported its second-quarter earnings today and the results were solid. Profits grew by 10% to $850 million, or 95 cents per share (98 cents per share on an adjusted basis), while revenues increased by 2.7% to $6.79 billion. A key driver continued to be HBO, with revenues up 17%. The division got a nice boost from licensing content to Amazon.
So at 16 times earnings, TWX is also trading at a reasonable valuation. Consider that FOXA is at 24X and CBS (CBS) trades at 18X. Besides, Time Warnerbelieves that its earnings will grow at a low-to-mid-teen rate for the next three to four years. In other words, the recent plunge really does look like a nice entry point for the stock.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.