FORTUNE — Charter Communications and Time Warner Cable are stuck in a prisoner’s dilemma. Charter looks to be the more aggressive prisoner, having made a $61.3 billion offer for its larger rival, and as a result could strike a better deal. The question is whether TWC will accept the lesser of two sentences.
In the actual prisoner’s dilemma game, the parties have two choices (with four possible outcomes) without knowing the other’s decision: to squeal on their accomplice, or to keep mum. The least punitive sentence comes when both parties stay quiet.
In this case, that choice would have been a merger. Twice before its most recent offer, Charter (CHTR) came to its bigger rival with a deal. It offered shareholders a paltry premium but some stock in what would be a combined company that was more attractive than each company alone. TWC (TWC) rejected both offers.
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Charter has now made a third offer public, claiming that it could go straight to shareholders to seek their interest if TWC doesn’t accept — we’ll call this squealing. On the face of it, the $132.50 cash and stock offer looks a bit low based on the seven-times EBITDA multiple that it values Time Warner Cable. (Other similar deals have been done at eight times.)
Yet consider TWC on its own. About a year ago, the company reported earnings that missed analysts’ expectations, sending the stock below $90 a share. Until rumors leaked to the market about a potential deal mid-year, the stock stayed well below $100.
Results haven’t improved much since then. TWC’s trailing 12 months of operating earnings was roughly flat between June and September, while the similar figure at Charter was up about 3%. Charter’s revenues have been growing at a faster clip too.
TWC now has to decide how aggressive it can be. Charter is invested in a deal too, so the cable giant has some control. (Charter’s stock has also increased since its first offer leaked, suggesting, unlike many mergers, it is good for the acquirer.) Cable companies are struggling against satellite rivals as well as alternatives that are offering top television shows and movies at lower prices, like Netflix (NFLX) and Hulu.
But like other prisoner’s dilemma scenarios, Time Warner Cable shareholders could benefit by accepting a less-than-stellar deal. They will still own 45% of the company in the end. Though they won’t be a majority owner, they can still reap the same benefits as Charter’s shareholders.
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TWC shouldn’t drag its feet. Had it accepted Charter’s cash and stock offer from last October and invested the cash in the S&P, it’d be nearly in the same place it is today. Any gains to Charter’s stock between now and a consummated deal will be a missed opportunity for TWC.
In mergers and even take-unders, shareholders are willing to accept low prices if they result in buying something better. Consider the final scenario — neither party can come to an agreement. Time Warner Cable’s stock could fall by more than a third. It would be, by far, the worst sentence.