On July 12, the Department of Justice announced that it was appealing the AT&T (NYSE:T)-Time Warner merger, asking the DC Circuit Court of Appeals to consider reversing its decision.
AT&T CEO Randall Stevenson told CNBC that he doesn’t see the courts reversing its decision to allow it to buy Time Warner.
“We think the likelihood of this thing being reversed and overturned is really remote,” AT&T CEO Randall Stephenson said July 13 on CNBC. “We’re about executing our plan.”
While integration will take time, the two companies are now legally joined at the hip. To force AT&T to separate Warner Media at this point would put all of the stakeholders at risk. So, if you’re an AT&T shareholder, I wouldn’t worry about the AT&T-Time Warner merger getting stopped in its tracks.
However, if you are a shareholder, be careful what you wish for because as I see it, there are seven reasons AT&T is going to blow the Time Warner merger despite its CEO’s confidence.
Problems for the Time Warner-AT&T Merger: Fails to Deliver Cheaper Service
As part of the judge’s 172-page opinion, Leon argued that AT&T buying Time Warner would lower costs for its customers. Unfortunately, as is often the case, the opposite happens.
In the most recent example of corporate B.S., AT&T upped the monthly fee for its cheapest DirectTV Now plan by 14% from $35 to $40 just days after Leon gave the thumbs up.
Sure, AT&T rolled out the usual consumer benefits arguments that companies make when looking for M&A approvals, but should the Democrats win back control of Congress after the mid-term elections in November, you can be sure they’ll revisit the AT&T merger at some point in 2019 to see if it has lived up to its promises.
Sadly, they’ll find it hasn’t.
Problems for the Time Warner-AT&T Merger: HBO Gets Ruined
This one is a big one given that HBO generated 29% of Time Warner’s overall operating income in 2017.
HBO doesn’t have the most content available but what it does deliver to customers generally wins critical acclaim. Although Netflix (NASDAQ:NFLX) got more Emmy nominations this year ending HBO’s 17-year reign as the leading nomination-getter, it still managed to pull in 108 nominations, just three shy of last year.
Unfortunately, that’s about to change now that AT&T’s in charge.
“We need hours a day,” AT&T Media CEO John Stankey said recently of the time subscribers spend watching HBO content. “It’s not hours a week, and it’s not hours a month. We need hours a day. You are competing with devices that sit in people’s hands that capture their attention every 15 minutes.”
AT&T wants HBO to compete head-on with Netflix by growing the amount of content available and by extension the number of subscribers — it’s currently 40 million in the U.S. and 142 million worldwide — and that’s going to completely change the network’s reason for being and formula for success.
Long-term, many experts believe that’s a mistake. It will be easy to see why when the quality of its content drops considerably.
Problems for the Time Warner-AT&T Merger: Huge Amount of Debt
This point is the one that bothers me the most because it represents the single biggest problem with corporate America today.
Big companies are up to their armpits in cheap debt; debt that’s going to get a lot more expensive over the next few years.
“AT&T is going to have $175 billion in debt. It currently pays an average of 3.75% on its debt,” I wrote last October. “Let’s assume the interest rate it pays stays around that level — it will cost the company $6.6 billion in the first year. A 1% increase in the rate paid equals a $1.7 billion increase in the payments to $8.3 billion annually. A 2% increase to 5.75% would mean a 53% bump to $10.1 billion.”
There are plenty of AT&T supporters out there who argue that Time Warner gives it plenty of cash flow — approximately $4 billion in free cash flow annually — to pay down its debt.
And while that’s true, it’s also possible that the assets it buys, such as HBO, deteriorate over time, much like AT&T’s previous acquisition of DirecTV, which has seen the company lose approximately one million cable TV and satellite subscribers since the $48 billion acquisition.
I believe its massive bet at this point in the credit cycle is unbelievably burdensome on a balance sheet that was already overly indebted.
And god help AT&T should a recession happen.
Problems for the Time Warner-AT&T Merger: Clash of the Corporate Cultures
AT&T’s CEO doesn’t believe there will be a culture clash between employees at the two companies — but how can there not be?
AT&T is a telecom company full of techies while Time Warner is a content company full of creative types. Merging those two is like blending oil and water; it’s just not that simple.
“It’s important that we preserve the culture,” AT&T’s CEO told CNBC recently. “John Stankey has spent a lot of time the first couple of weeks making sure that he’s touching the employees, touching the talent. Making sure that they understand that they will be left to do what they do best.”
The problem with words is they also require action to be truly impactful. So far, AT&T has shown its true stripes early in its ownership of Time Warner by raising fees and proposing a significant change in HBO’s DNA. This could see many its most creative employees jump ship.
I just don’t see the two work cultures not clashing.
Problems for the Time Warner-AT&T Merger: Innovation Disappears
The chief competition economist for the European Commission, Tommaso Valletti, studied the effect of mergers on research and development and innovation at large companies.
Valletti found that in specific industries and markets, mergers reduce overall innovation with customers ultimately paying the price.
Interestingly, Time ran a story in 2014 entitled “Mega-Mergers Are Killing Innovation” that came on the heels of AT&T’s acquisition plans for DirecTV.
“Consolidation can be good for consumers as bigger companies have the resources to innovate and provide new products and services which might otherwise never materialize,” wrote Time contributor Sanjay Sanghoee. “However, the vertical integration of the telecommunications and technology sectors can also restrict innovation due to decreased competition and the limitation of research to specific technologies that support existing business lines.”
I don’t think there’s any doubt the merger of these two companies will result in less money and time being spent on innovation.
Problems for the Time Warner-AT&T Merger: Synergies and Cost Savings Fall Short
The buzzwords of big mergers are synergies and cost savings. Executives throw these sorts of numbers out there as a carrot for investors and rarely do they materialize to the extent advertised.
In the case of AT&T and Time Warner, the merged entity expects to reduce costs by $1.5 billion annually by 2021 while also generating $1 billion annually in increased revenues from synergies between the two companies.
If it were to use the entire $2.5 billion to pay down debt, it could shave about 14% off its overall indebtedness over the next decade without accounting for any of the $4 billion in annual free cash flow Time Warner already generates.
So, let’s say that in addition to the $2.5 billion in synergies, the company uses the entire $4 billion also to pay down debt; AT&T could cut 36% of its debt over the next ten years.
But that’s a big if, because generally companies overestimate the synergies and savings to be gained from mergers.
“The average acquirer materially overestimates the synergies a merger will yield. These synergies can come from economies of scale and scope, best practice, the sharing of capabilities and opportunities, and, often, the stimulating effect of the combination on the individual companies,” stated a McKinsey & Company article from 2004. “However, it takes only a very small degree of error in estimating these values to cause an acquisition effort to stumble.”
It might be a 14-year-old quote, but in my experience, nothing has changed when it comes to large mergers like the one pulled off by AT&T.
In five years, I’m sure investors will have forgotten the promises Randall Stephenson made regarding synergies and cost savings.
Problems for the Time Warner-AT&T Merger: Big Deals Generally Fail
While the odds of a merger succeeding are much higher than winning a lottery — KPMG estimates that about one-third of mergers in North America add value — AT&T shareholders ought to lower their expectations for success.
KPMG also found that nearly 70% of mergers in North America either deliver zero value to shareholders or reduce it.
Four reasons why mergers fail, according to five-time CEO Margaret Heffernan include momentum, not enough due diligence, debt and power struggles.
Momentum means that once AT&T launched the regulatory process to get the merger approved, there was no way it was going to put the brakes on the deal.
Every acquirer likes to think it’s done it has due diligence, but that rarely turns out to be the case despite their multi-billion-dollar price tags.
The third reason, debt, I’ve already spoken about.
Finally, somewhat akin to the corporate culture discussion, rarely are mergers equal partnerships. There are going to be bruised egos at Time Warner — think HBO — creating friction between the two entities.
Stephenson says Time Warner will be run entirely independent of AT&T; history suggests his words won’t accurately reflect what’s happening.
As of this writing Will Ashworth did not hold a position in any of the aforementioned securities.