Critical Analysis of AT&T-Time Warner Merger

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Executive Summary

AT&T, Inc. (NYSE: T) has agreed to acquire Time Warner, Inc. (NYSE: TWX) in a deal valued at $85.4 B for a combination of cash and AT&T stock. The blockbuster merger between the two giants was completed on June 15, 2018. As a result, AT&T issued 1,185M shares of common stock and paid $42.5B in cash; net debt from Time Warner, amounting to $180.4B. For each share of Time Warner, a shareholder is entitled to $53.75 of cash and 1.437 shares of AT&T common stock. As a result, highlights of full year consolidated result of AT&T as of December 2018 looks as below (referenced from current 10K report):

Diluted EPS of $2.85 as reported compared to $4.76 in the prior year (2017 impacted by tax reform)
Adjusted EPS of $3.52 compared to $3.05 in the prior year
Cash from operations of $43.6 billion, up 15%
Capital expenditures of $21.3 billion
Free cash flow of $22.4 billion, up 36%
Dividend payout ratio of 60%
Consolidated revenues of $170.8 billion

Key Issues

The biggest issue grappling the deal was the anti-trust lawsuit (as per a report by Investopedia):

Because of the size of the two companies and their broad reach across many different areas of business and culture, the merger would have a profound effect across the U.S. Detractors argue that it could lead to higher prices and harm competition in the industry.
Regulators are largely concerned with protecting competition and the consumer when it comes to cases such as these. AT&T could coerce other cable companies to pay more for the rights to carry popular television shows and channels. This would likely mean an increase in cost to the consumer. The Justice Department believes that this process might add $436 million in extra fees to cable subscribers each year.
Besides the major business implications of the AT&T-Time Warner merger, the antitrust lawsuit will have much broader implications for the world of mergers and acquisitions (M&As) in general. Indeed, the case would be a bellwether for future mergers and acquisition deals.

Finally, AT&T acquired Time Warner after clearance from the appeal made by Department of Justice with respect to the earlier decision given by the US District Court, Washington, D.C.

Other key issues in the merger of the two companies would be the integration issues of the two giants:

Retaining Top Talent: Retaining executive leadership is a challenge given the restructuring of the leadership team for the combined entity. As of now, several high-profile exits have already occurred, the pronounced ones being the exits of CEOs of HBO and Warner Bros.
Cultural Synergies: AT&T should take learnings from the failed merger of the erstwhile AOL Time Warner to make a successful and sustainable merger. Both companies have different work cultural attributable to the different industries they operate in, and as such, careful consideration of the cultural aspects should be done by the leadership team

Deal Rationale

The future of media entertainment is rapidly converging around three elements required to transform how video is distributed, paid for, consumed and created. Viewers have a plethora of options to choose from to watch content and have more power to dictate the rules of the game in terms of price point, customer service, live or scripted content, and geographical reach of the players. Media executives increasingly believe that content creation and distribution must be married to survive against technology companies. Those companies, even though, started producing their own shows in just the last several years, they now spend billions of dollars a year on original programming, and users can stream the video on apps in homes and on mobile devices, putting pressure on traditional media businesses.

By teaming up with Time Warner, AT&T can successfully compete with companies like Facebook, Amazon, Google, and Netflix collectively called FANG. It would also aim to collect usage data regarding viewership of the content, with the ultimate goal being able to construct a digital advertising arm to compete with these major rivals. AT&T, with its acquisition of Time Warner would bring together:

Premium Content: Broadly distributed, a robust premium content portfolio that combines leading movies and shows from Warner Bros., HBO and Turner, along with more targeted digital content from Bleacher Report, FilmStruck and AT&T’s investment in Otter Media, among others.
Direct to Consumer Distribution (D2C): AT&T has more than 170 million D2C relationships across its TV, video streaming, mobile and broadband services in the U.S., mobile in Mexico, TV in Latin America, in addition to D2C digital properties such as HBO NOW, Boomerang, FilmStruck and CNN.com.
High-Speed Networks: AT&T‘s leading wireless and fiber network, including investments in new technology such as 5G, will provide the network bandwidth required as customers increase engagement with premium video and emerging 4K and virtual reality content.

As such, the mega merger would create a media and telecommunications powerhouse, reshaping the landscape of those industries. According to CEO John Stankey, content spends at WarnerMedia would be competitive to that of Netflix, Amazon and Apple. This is another benefit of the AT&T/Time Warner merger, and is committed to launching a compelling and competitive product that will serve as a complement to the existing businesses and help expand the reach by offering a new choice for entertainment with the WarnerMedia collection of films, television series, libraries, documentaries and animation. It will bring a fresh approach to how the media and entertainment industry works for consumers, content creators, distributors and advertisers.

Revenue Implications / Synergies

The company expects the acquisition to provide significant financial benefits:

Accretive year-one adjusted earnings per share and free cash flow; strengthened dividend coverage
Increased synergies to $2.5 billion
$1.5 billion in annualized cost synergies by end of year 3 following close
$1 billion of annualized revenue synergies by end of year 3
Maintain a solid balance sheet and improved credit metrics with net debt to adjusted EBITDA 2.9x at close
AT&T’s growth would result from developing its next-generation streaming video platform and targeted advertising capabilities. AT&T expects to build on its successful history of managing technology transitions as the video industry moves from linear to over-the-top (OTT) services
AT&T expects to expand its video offerings to better address each customer segment and grow its total video subscriber base. This includes AT&T’s top-of-the-line services DIRECTV and U-verse and OTT service DIRECTV NOW
AT&T expects to be the first U.S. company to launch a standards-based mobile 5G service in 2018

Cost Implications / Synergies

AT&T expects annualized cost synergies of $1.5 billion by the end of the third year after close primarily from consolidation of back-office systems such as IT, Finance, Legal etc. The sharing of facilities in many locations within US and outside would also bring cost synergies.

Headcount / Facilities Impact

Headcount: at the time of the merger, AT&T has a headcount of 254,000 and Time Warner has a headcount of 30,400. There is an anticipation of cut-down of jobs in the back-offices such as HR, IT, Finance and Legal due to integration of the two entities. Careful evaluation and a well-thought out plan needs to be laid out to handle such a sensitive issue
Facilities: There would be duplicity in the office spaces with facilities in the same cities within the different states of United States. A long-term look at the facilities mapped with the growth plan would be a better approach to consolidate the facilities within US and globally

Systems Implications

An important part of the integration plan would be to have a unified IT system with similar back-end IT infrastructure, cloud solutions, ERP and CRM system for a seamless experience for internal and external stakeholders.

Deal Terms

Total transaction value of the M&A is $85.4B. The enterprise value of post-merger AT&T, Inc is $409.59B
AT&T will acquire all outstanding shares of Time Warner for a combination of cash and AT&T common stock. Because AT&T’s price was way below the bottom of the collar, Time Warner holders got only about $46.70 of AT&T stock rather than $53.75. In all, Time Warner holders got a total of about $100.45 a share rather than the stated $107.50
AT&T funded the deal through free cash from its operations, and a mix of debt and equity financing
The deal was completed on June 15, 2018

Deal Team

JPMorgan, Bank of America Merrill Lynch, and Perella Weinberg are advising AT&T on the buy side
Thomson Reuters, with JPMorgan and Bank of America Merrill Lynch providing a $40 billion bridge loan
Allen & Co., Citigroup, and Morgan Stanley are advising Time Warner on the sell side

These firms could earn in fees, according to the consultant Freeman & Co.:

AT&T buy-side advisory: $90 million to $120 million to the advisory group (Perella Weinberg, JPMorgan, Bank of America)
AT&T $40 billion bridge loan: $110 million to $130 million to arrangers (led by JPMorgan and Bank of America)
Time Warner sell-side advisory: $110 million to $140 million to advisory group (Allen & Co., Citigroup, Morgan Stanley)

Integration Plan

The consolidation of the combined entity began on June 15, 2018. No officially published integration plan is published, but a look at similar M&As, the integration plan would look like:

Part I – Closing and Day One: Communications, Operative Structure, Systems & Controls, Business Plans/Budgets
Part II – Post-Merger Integration: The Process, Visioning, Success Factors, Working Methods & Tools, Reporting
Integration Checklists for different functional streams (Finance & Control, HR & Personnel, Legal, Facilities, IT)

The new entity is divided into four strategic business groups as below:

AT&T Communications provides mobile, broadband, video and other communications services to U.S.-based consumers and nearly 3.5 million companies – from the smallest business to nearly all the Fortune 1000 – with highly secure, smart solutions. Revenues from these services totaled more than $150 billion in 2017.
AT&T’s media business, now coined WarnerMedia, consists of HBO, Turner and Warner Bros. Together, these businesses had revenues of more than $31 billion in 2017. A new name for this business will be announced later.
AT&T International provides mobile services in Mexico to consumers and businesses, plus pay-TV service across 11 countries in South America and the Caribbean. It had revenues of more than $8 billion in 2017.
AT&T’s advertising and analytics business, now coined Xandr, provides marketers with advanced advertising solutions using valuable customer insights from AT&T’s TV, mobile and broadband services, combined with extensive ad inventory from Turner and AT&T’s pay-TV services.

The integration plan would focus on implementing revenue and cost synergy while maintaining the work cultures in each sub-division.

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