Jumping to the Wrong Conclusions on the AT&T/Time Warner Merger

Within hours of the announcement of the proposed AT&T/Time Warner merger last month, Donald Trump weighed in strongly opposing the deal for concentrating too much power in the hands of too few. It’s understandable that Trump would not want the parent of CNN to amass any more market power. But in a rare instance of policy agreement, Hillary Clinton’s surrogates also signaled immediate antitrust concerns with potential adverse consumer impacts, mindful of widespread populist sentiments in the electorate.
 
On the other side, several business pundits were more bullish, lauding AT&T for responding to the need to do something to strengthen its position in the brutally competitive wireless service provider business, while others suggested now was a good time to secure debt financing to pay for an acquisition, before the Fed raises interest rates.  As for Time Warner, its CEO Jeff Bewkes was generally given good marks for securing a higher price for his shareholders than 21 Century Fox was willing to pay two years ago.
 
But none of these hasty pronouncements get at the crux of what would ultimately make this an attractive deal for these two corporate giants.  Simply put, the key question is whether the proposed merger will help AT&T and Time Warner to bring better content more efficiently to more customers, faster and at lower prices than either company could provide on their own.  The answer is far from clear.

AT&T’s CEO Randall Stephenson attempted to preempt the chorus of antitrust concerns by noting that the proposed merger is a case of pure vertical integration, marrying a content provider and a telecom distribution services company that have virtually no direct business overlap.  In this regard, the Time Warner deal is fundamentally different from AT&T’s offer five years ago to acquire T-Mobile USA, which was blocked by the Justice Department on fears that the proposed horizontal merger would reduce competition and harm consumers.
 
In retrospect the regulators proved to be right in seeking to protect consumer interests.  After being forced to withdraw their acquisition offer, AT&T had to pay a $4 billion breakup fee that T-Mobile used to significantly upgrade its wireless infrastructure.  Under the leadership of a new CEO, John Legere, T-Mobile emerged as a fiercely capable competitor, pioneering numerous marketing initiatives giving consumers more flexible mobile services at lower prices. T-Mobile has been growing at AT&T’s expense, adding about 5.5 million new subscribers – nearly three times more than AT&T – over the past eighteen months.
 
While AT&T has been struggling in the competitive, saturated wireless services market, Time Warner also faces the prospect of growing competition for quality content and consumer engagement from traditional and new players, most dauntingly including Facebook, Google, Amazon and Netflix.  So both players have legitimate reasons to seek new ways to strengthen their capabilities and relevance amidst industry transformation.
 
AT&T’s CEO notes that “the world of distribution and content is converging and we need to move fast … to curate, [and] to format content differently for [emerging] mobile environments.”  Can the proposed vertical integration merger fulfill Randall Stephenson’s vision? 
 
Some of the most extraordinarily successful companies in other industries have built their business by exploiting a highly vertically integrated business strategy.  Exemplars include Apple, Ikea and Zara, each of whom has been able to deliver superior and unique products to market faster and cheaper, as a result of the extensive assets and capabilities built organically across their value chains over time. 
 
But the strategic context underlying the AT&T/Time Warner deal is vastly different.  AT&T has traditionally competed vertically by trying to attract as many customers as possible for non-exclusive products and services sold through its branded distribution channels. Time Warner on the other hand is a horizontal player, attempting to attract as many distributors as possible to deliver its proprietary content to market at the highest possible prices. Putting these two companies together creates significant challenges, which provides a very tenuous path to victory.
 
Stephenson’s vision is that the AT&T/Time Warner union will be able to create unique products and services faster and more efficiently, positioning the merged companies to become competitively advantaged.  But it will have to do so without unduly eroding the profits Time Warner currently earns by selling proprietary content through competing telecom distribution channels, and without incurring the regulatory wrath of the Justice Department, who has already signaled concerns with growing industry concentration.  Threading the needle to satisfy all three of these requirements for a successful deal will not be easy.
 
Wall Street likes businesses with predictable, stable business outlooks.  But in assessing the prospects for the proposed merger of AT&T and Time Warner, the reality may be a bit of damned if you do or don’t.

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