AT&T-Time Warner Merger: Everybody Wants To Rule The World?
Mark Rogowsky
AT&amp;T's track record on mergers and acquisitions isn't exactly stellar. Now it's buying Time Warner (itself the target of arguably history's worst merger), to solve its problems of maturing markets and slowing growth. But AT&amp;T seems unconcerned that Time Warner might ultimately make matters worse.
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Forbes
They say you can't go home again, but AT&T may not have gotten the message. Ever since the company was shattered into pieces through an antitrust case, AT&T has been trying to buy or merge itself back into relevance in telecommunications. The breathtaking $85 billion deal to takeover Time Warner is just the latest move in a three-plus decade saga. The history of the company's misguided efforts to own the future don't bode well.

Past is prologue?

When AT&T was working through its original breakup plan, it famously decided the future wasn't in wireless. Thanks to its consultants at McKinsey, AT&T believed fewer than 1 million people would own cellphones in 2000. More than 100 million did. The only good news for AT&T was that it realized its error long before 2000 and got back in the mobile game with a (then) blockbuster $13 billion deal for McCaw in 1994.

Cellular service was much more competitive back then, with regional players and an upcoming auction that would usher in a temporary free-for-all as subscriber growth soared. That chaos left the giant hungry, and AT&T would make a bigger splash by buying cable giant TCI in 1998 for $48 billion -- three times the size of the McCaw deal.

But the folks at AT&T again failed to see what was coming. This time the future was one one where nearly every home in the U.S. that could sign up for broadband would sign up for broadband. And cable would dominate. Unfortunately, AT&T sold its cable operations to Comcast in 2002. It also spun out its wireless operations, which led to yet another blockbuster deal as the joint venture Cingular acquired AT&T Wireless. Within a year, one of AT&T's original children would buy the carcass of the company, which still had operations in long distance, beginning the final stage of rebuilding the old monopoly.

The problem was that it left the new (old?) AT&T in a lot or moribund businesses like providing local phone service -- not entirely unlike where AT&T sits today. Still after the mergers all settled, a strong decade for AT&T would follow. A bet on Apple's iPhone gave the company a leg up on selling smartphones and mobile data. In addition, some clever technology allowed AT&T to offer cable TV through its Uverse brand.

How did we get here?

Fast forward another decade, though, and things stopped looking rosy. Uverse delivered video and broadband over old-school telephone wires, which lacked the bandwidth to satisfy customers hungry for data or high-quality HD television signals. Unlike Verizon (the company that represents the other half of the old monopoly), AT&T failed to invest in fiber-optic infrastructure that would allow it to become a strong player in broadband. Add to that a maturing smartphone market, meaning little growth would come from mobile. And then there's the one deal AT&T failed to complete in the last decade, which has come back to haunt it.

Five years ago, AT&T tried to buy T-Mobile in an effort to do the "last big acquisition" in mobile. Had that merger gone through, the likely outcome would have been a relatively tiny Sprint unable to compete and a dominant duopoly of Verizon and AT&T. Even customers of those latter two should now understand that T-Mobile under its CEO John Legere has been good for everyone. With four carriers competing, prices have come down, coverage has improved and innovative (albeit controversial) ideas like not counting certain video and music services against your data budget have flourished.

So what's a monopolist to do? Facing minimal growth, AT&T tried to reboot the TCI deal, with an acquisition of DirecTV in 2014. The price tag of $48.5 billion nearly identical to the 1990s cable deal for TCI. While the deal had some positive attributes -- AT&T could now sell TV across most of the country, bundling of services makes them stickier -- the critical flaw is that cable and satellite are not growth businesses either. At its height, the video bundle was in every nearly every TV home; cord cutting is beginning to shrink that pie. To make matters worse, nearly $50 billion made AT&T no stronger in fixed broadband where it's now spending on fiber in a belated effort to catch up.

To the future!

That meant the DirecTV deal, which seemed uninspired at the time, couldn't possibly be a long-term solution to AT&T's malaise. If anything, it added to it. Now AT&T faces not only a saturated mobile market that can't reasonably contribute growth but also a very slowly dying television market that almost certainly will shrink.

Enter Time Warner, which itself has been through the merger/spinoff ringer. Few can forget the ill-fated AOL-Time Warner deal that is on nearly every list of the worst mergers of all time. Since its unwinding, Time Warner has done everything in its power to slim down, dumping its cable operations into a separate company and later the legendary magazine division. The remainder owns cable channels including HBO and CNN and the Warner Brothers movie studio.

In short, it's a video content company which is partly why AT&T made clear that "the future of video is mobile and the future of mobile is video" in its merger announcement. But stating that and backing it with business logic are two different things. AT&T already benefits from mobile video, whether you're sitting and binge watching Netflix or checking out the latest viral video on YouTube. For that matter, AT&T profits when you watch Game of Thrones on your phone -- no matter who owns it.

Time Warner, similarly, gets to sell HBO through every cable operator, including DirecTV and Uverse, as well as direct to consumer. Many mergers are sold to shareholders on a promise of "synergy" -- the idea the whole is greater than the parts. In this case, AT&T wastes little time making that claim. "AT&T expects $1 billion in annual run rate cost synergies within 3 years of the deal closing. The expected cost synergies are primarily driven by corporate and procurement expenditures," the press release claims. While that might sound like a lot, it's noise.

Cash (flow) is king

What's left to sell this then? A combination of cash flow and corporate-speak. Let's dispense with the former first. Telecommunications companies love cash flow. That doesn't make them unique, every company wants to have cash to work with, but specifically telecom firms love cash flow as a metric on which to be judged. AT&T says the merger will give it higher earnings per share and free cash flow. It claims the deal will be accretive -- that is a bonus to earnings -- in its first year. When viewed through that narrow lens, this could arguably be a sound deal. Nearly every merger destroys value, but if you can actually generate greater profits via an acquisition that's something.

Unfortunately, there aren't any free lunches here. That future of video on every screen is already happening and none of the innovation there is coming out of old-school cable programmers or mobile carriers. To make matters worse, the last time this "perfect match" (to borrow a phrase from AT&T's press release) of cable company plus programmer was tried, Comcast bought NBC Universal. It failed to generate any magic. Comcast hasn't arguably harmed NBC, but neither does anyone believe the deal brought anything special of value to either side.

What Comcast already knows is owning content doesn't really allow you to benefit as you have to sell to everyone to maximize the value of that content. AT&T couldn't realistically limit the sale of HBO without massacring the value of HBO. And while its true AT&T has a direct relationship with mobile customers that Comcast doesn't, it's not at all clear that changes the equation. In fact, AT&T arguably is already in serious trouble. The DirecTV bet and huge reliance on wireless means AT&T is already fighting two wars of attrition. Time Warner won't help AT&T in either of those.

Fast forward 10 years, and it might be the case AT&T has instead opened up a third front. Much of Time Warner's revenues come from those cable bundles that are slowly going away. CNN, TBS and TNT each have more than 90 million customers via those bundles. That's a few dollars per month from 2 in 3 American households. Betting on even that continuing into the 2020s feels like much less than a sure thing. One might even say it represents a fundamental misread on a future where video is mobile and mobile is video. One where old-school linear TV is viewed only by older folks and new-school video comes from "channels" that are just getting launched, like Snapchat. One where $85 billion might be better spent on either trying to adapt to avoid a slow slide into irrelevance.