Wall Street loves a rumor. The bigger and more insane the rumor, the more Wall Street likes it. That’s because Wall Street doesn’t have to run the results of putting two big sloppy conglomerates together. The arbs and investment bankers take their money up-front and wave sayonara to the managers stuck in a leaky ship together. So it is with the “discussions” AT&T Inc. (NYSE:T) and Time Warner Inc (NYSE:TWX) reportedly had recently over a possible merger.
It’s not going to happen in a rational universe.
Today’s TWX was created by jettisoning its cable operation, now owned by Charter Communications, Inc. (NASDAQ:CHTR). Today’s AT&T was created by the former Baby Bell buying DirecTv with profits from its AT&T Wireless unit, then offering three conduits for TV products — phone, satellite and wireless.
Why the Rumor for TWX and AT&T?
Since completing the purchase of NBC Universal in 2013, cable operator Comcast Corporation (NASDAQ:CMCSA) has traded more like an entertainment stock than a distribution stock. After the deal, shares are up almost 70% in value, in line with other entertainment companies like Walt Disney Co (NYSE:DIS) and TWX, which are up more than 80% each.
But it has traded stability, which a huge capital structure like that of T stock needs, for risk. Over the last year, AT&T shares have outperformed the entertainment companies, gaining 14% in value against just 4% for Comcast. T stock has also delivered shareholders almost $2 in dividends for a yield that’s near 5%.
The idea investment bankers are spinning is that AT&T ownership would let TWX management hide inside a larger entity, enabling them to make longer-term plans. That’s how things seem to have worked out at NBC Universal, whose managers are insulated from the stock market by the larger size of CMCSA.
The idea is also to match the moves rival Verizon Communications Inc. (NYSE:VZ) has made in internet content, where it bought AOL and then the operating units of Yahoo! Inc. (NASDAQ:YHOO) in relatively quick succession. Vertical integration is the song the bankers are singing.
A Capital Sink
But it’s just as likely that T managers would find themselves buffeted by programming decisions they have no business making, and that the dividend millions of retirees depend upon could quickly come under threat. AT&T is based in Dallas, a more conservative jurisdiction than New York, and this could affect both the news judgement at CNN and the entertainment decisions at Time Warner.
As an entertainment company, owning cable channels and a movie studio, TWX stock earnings are naturally lumpy, differing by as much as 30% quarter-to-quarter, depending on how the ratings do and what the movies earn at the box office. T stock earnings fall in a much narrower range, and most net income goes right out as dividends, while Time Warner is used to banking most of its net income to make up for the lumpiness.
AT&T managers also face long-term capital planning and expenses that far exceed what a movie or cable operator face. T stock has $120 billion in debt and needs to keep the costs of that debt down with a solid credit rating. Unless it wanted to dilute its own shareholders dramatically, AT&T would probably have to take on more debt to complete a deal.
The companies are completely different, which may be what TWX sees: stability and independence for its management team. But what T stock would get out of the combination is dubious.
Bottom Line on T Stock
Despite how silly the idea may be, rumors do move markets. Time Warner shares rose nearly 5% on the reports, which came out late in the afternoon of Oct. 20, before giving up half those gains before the close. TWX stock gained marginally overnight, and once it’s clear the rumors will not be followed by action, you can expect them to return to their pre-rumor level of about $80 per share.
As for T stock, shares fell about 30 cents on the news, and could be had in early trading October 21 for a price-to-earnings multiple of 16.7, which is somewhat lower than the cost of the market as a whole. Income investors should take note.
Dana Blankenhorn is a financial journalist who dabbles in fiction, his latest being The Reluctant Detective Travels in Time. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities.