Wall Street Thinks AT&T’s $85 Billion Takeover of Time Warner Will Be a Bust

October 24, 2016, 5:21 PM UTC

AT&T and Time Warner might have declared that the “future of video is mobile and the future of mobile is video” when they announced their $85.4 billion deal over the weekend, but Wall Street isn’t sure the combination will have a place in that future.

The largest deal of the year is currently facing regulatory scrutiny from the Justice Department. Meanwhile, presidential nominees Hillary Clinton and Donald Trump have spoken out about the deal with varying levels of skepticism. Trump said the merger would “destroy democracy,” while Clinton’s campaign spokesperson Brian Fallon said the Democratic nominee thinks “regulators should scrutinize it closely.”

So while AT&T (T) offered $107.50 per share—half in stock and half in cash—for Time Warner (TWX), shares of the latter company are trading at an uncommonly large discount—18.6% lower than AT&T’s offering price on Monday.

Nonetheless, famed value investor, Mario Gabelli, who is a major shareholder in both companies, told CNBC on Monday that he had “no problems with [the deal],” and that it would prepare the combined giant for the next decade. He, though, was one of the few fans.

A team of Goldman Sachs analysts revealed their initial thoughts on the deal, maintaining the equivalent of a “Hold” rating on AT&T’s stock.

AT&T’s attempt to become a major media player through this proposed transaction would take it further beyond its core business of network access. However, this is broadly consistent with its increased emphasis on being an end-to-end supplier of network access and digital media, a strategy that CEO Randall Stephenson discussed at length during Communacopia this past September. In that sense, this proposed transaction would not be a complete break with the company’s evolving strategic direction.

Credit Suisse‘s research team, led by Omar Sheikh, downgraded Time Warner’s stock on the news, saying other companies, such as 21st Century Fox, are unlikely to start a bidding war for Time Warner.

That said, access to video content and access to distribution platforms is important to everyone in the traditional and online video ecosystems. For this reason, the emergence of two very large vertically integrated players (Comcast and AT&T) will certainly prompt fierce opposition to the deal in the industry, and may add impetus to both content companies and distribution companies to consider their own scale.

We believe attention will focus the strategies of mid-sized media networks—if relative scale confers negotiating leverage, the most “vulnerable” networks in the ecosystem will be Discovery Communications, Scripps Networks Interactive (Not Rated), AMC Networks (Not Rated), CBS and Viacom.

Jefferies equity analysts led by Mike McCormack, kept the firm’s coverage of AT&T at “Buy,” saying the deal will be “modestly accretive,” but is likely to run into heavy regulatory scrutiny.

Given the marrying of the nation’s largest payTV operator, and one of the top content owner/creators, we expect a lengthy and arduous regulatory process. The Department of Justice is likely to garner greater attention given the vertical integration. The 2011 Comcast-NBCU consent decree is likely to serve as a blueprint, though changes in the media landscape warrant a refreshed look. Key issues are likely to include: (1) the availability of content to MVPDs(multichannel video programming distributor) and OTT(delivery of content via internet) providers at reasonable economic terms; (2) limitations on bundling of programming; (3) some degree of broadband enforcement to limit content favoritism; and (4) mechanisms to monitor and enforce deal conditions. While the deal inherently does not remove a competitor, approval is by no means a given, and we expect heavy scrutiny, with many outside party opponents. The changing political landscape could also influence the review.

William Power, who covers AT&T over at Baird, pointed out in a note titled “Jon Snow to the Rescue?”:

  • Deal rationale. Foremost, the transaction takes advantage of AT&T’s balance sheet power, and helps diversify away from the increasingly competitive wireless space, and financially should be modestly accretive to earnings per share and cash flow.
  • What does it really gain strategically? Given it already had access to Time Warner”s content, it’s not readily apparent to us what strategic benefits it derives near term, though it’s betting on the increasing mobile/video/content convergence, owner’s economics and more targeted advertising to pay dividends.

Oppenheimer analysts led by Timothy Horan noted that the $85.4 billion deal—the largest of the year—will be surrounded by political chatter. But the Department of Justice has never rejected a merger between companies at different levels of the production chain. AT&T debt load may also limit its ability to grow following the deal.

While AT&T-Time Warner is a vertical integration (these deals have usually cleared, and are not subject to Federal Communications Commission review), we expect to see major political chatter. Additionally, though AT&T has committed to 2.5x leverage by the end of Year 1 (and an investment-grade debt rating), the debt load (~$185B) restricts AT&T’s ability to allocate capital beyond deleveraging.

Drexel Hamilton managing director Barry Sine, who covers AT&T, meanwhile has recommended that investors swap out of AT&T in favor of its competitor Verizon to “Buy” on the news.

“AT&T is probably not going anywhere over the next couple of years,” Sine told Fortune, adding that while AT&T has a more unfocused strategy, Verizon is specifically targeting mobile and Gen Z audiences. “Full synergies won’t start happening until 2021.”

Sine wrote in his Monday note, downgrading AT&T’s stock to “Hold”:

We believe that the transaction will be a distraction in 2017, dilutive in 2018 and will offer few if any financial or strategic synergies once regulator’s conditions are factored in.
We are also upgrading shares of Verizon Communications (VZ) to Buy as we believe that Verizon is now better positioned for accelerating earnings growth in 2017 as it exits its “transition year” in 2016.

With approximately 1.1 billion AT&T shares being issued by AT&T to Time Warner shareholders, we expect a significant overhang to put pressure on AT&T shares.

Shares of Verizon (VZ) have ticked upwards slightly by 0.58% in trading Monday.

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