- Overview of the details of the Comcast and Time Warner merger deal.
- Analysis and rational as to why the deal will go through contrary to popular belief.
- Risk/reward analysis of the type of trade that could best capitalize on the merger and how best to profit from it.
The Comcast Corp. (NASDAQ:CMCSA) merger with Time Warner Cable (NYSE:TWC) that was announced back in February is set to make Comcast the largest cable and broadband provider in the country, but how can the average investor profit from it? Given that the deal is an all-stock deal valued at $45.2 billion it makes it a bit tricky to really know what the actual buy-out price will be. One thing is for sure provided the deal goes through Comcast would essentially have market share across the entire country with nearly a 30% market share of all TV and broadband services.
Even though the deal between these two firms is friendly in nature, it is highly unlikely that the U.S. antitrust regulators will look on the deal in such a manner. When or if this deal goes through the sheer size of Comcast coming out of the deal has both regulators and the industry as a whole a bit concerned. One of the largest concerns post-merger is that Comcast would essentially have the ability to greatly influence content providers and ultimately the overall costs that could be charged back to consumers. After the announcement Comcast Chief Executive Brian Roberts said he was confident about getting the green light from regulators and that the deal would be a net positive for consumers.
Prior to this deal coming together both Liberty Media (NASDAQ:LMCA) and Charter Communications (NASDAQ:CHTR) had made several bids to try and acquire Time Warner, with the most recent bid coming from Charter valuing the company at $132.50 per share. All of the bids put forth by Charter and Liberty were rejected by Time Warner, citing that all of the bids were too low. Rob Marcus CEO of Time Warner was quoted saying that he believed the true buy out value of Time Warner was somewhere in the $160 per share level, level that Comcast ultimately ended up coming up with.
After news of the deal broke Time Warner shares spiked up 7% to around $144.50 per share, which was still short of the targeted $158.82 per share price that the deal would net, if approved, Comcast share expectedly fell 3.5%. Since the deal is an all-stock deal the actual price that Time Warner shareholders would receive is completely dependent on the price of Comcast at the time of the acquisition.
When the announcement broke back in February Time Warner shareholders were set to receive $158.82 per share for their stock shares. The ratio of Comcast to Time Warner shares is set at 2.875. Meaning that as Comcast shares fluctuate in price as does the actual buy out price that Time Warner shareholders would receive.
Since the deal was first announced about 45 days ago Comcast stock has continued to decline in value, testing the $50 per share level. At this price point the Time Warner deal which was originally valued at around $159 per share, would now come in at $143.75 per share. Due to previously mentioned buy-out ratio, as Comcast shares have continued to trade lower so has Time Warner shares. After the initial announcement Time Warner shares spiked up to $144.50 per share, they have since come down to $135.50 per share.
Why the Merger will happen
Before we can even begin to discuss the best way in which to capitalize on the Time Warner/Comcast deal we must first believe that the deal is going to happen.
Below are some of my counter arguments to some of the main talking points as to why the deal will fail.
· Why it's not a merger of two direct competitors: Currently Time Warner and Comcast are not direct competitors. Both firms target markets in entirely different cities and regions of the United States. In a direct quote from Comcast CEO Roberts ""Significantly, it will not reduce competition in any relevant market be because our companies do not overlap or compete with each other," Roberts said, "In fact, we do not operate in any of the same zip code." If this merger goes through nothing really will change. People that used to only have Time Warner as their one choice for a cable provider will still only have one choice, except it will now be labeled Comcast. Additionally, cable providers are already notoriously known for raising rates every year, so any type of rate increase that were to occur after the first year of the acquisition would actually be expected.
· Why Comcast still won't dominate broadband: The merging of the two firms would only (I say only lightly) give Comcast a 30% market share of the existing wireless and broadband network. Unlike the attempted merger of AT&T (NYSE:T) and T-Mobile (NYSE:TMUS) back in 2011 this deal would not make Comcast completely untouchable. I say that because unlike the wireless carrier business where the barriers to entry are extremely high. The cable and broadband market is already seeing new comers entering the market to compete. Both Verizon (NYSE:VZ) and Google (NASDAQ:GOOG) are increasing their presence in the broadband market by offering fiber connections and wireless cards, as well as, cheaper/faster internet to consumers. Not to mention, the number of cities that are starting to offer city wide Wi-Fi. Additionally, unlike cable TV which usually already has a monopoly in any given city, most cities and regions have a larger pool of wireless/broadband options at their disposal creating a truer market for pricing.
· Why Comcast's cable presence is still threatened: I will concede to the fact that in most cities there is usually only one cable TV provider for consumers to choose from. This in essence already creates a bit of a monopoly for that provider in that city/region. As technology has evolved, so has competition. As we already know, firms like Amazon (NASDAQ:AMZN), Hulu, and Netflix (NASDAQ:NFLX) have already greatly challenged the traditional cable TV platform. Now newcomers like Google and Apple (AAPL) are also looking to enter this market with actual streaming TV platforms that would allow them to gobble up more market share away from giants like Comcast. The era of cable cutters choosing to move toward an on-demand, web-based, cheaper option is here and will only create more competition and increased consolidation for larger traditional firms like Comcast. Of course, I would be remiss not to mention the most obvious competitor to traditional cable TV, the satellite providers. Firms like DirecTV (NASDAQ:DTV) and Dish Network (NASDAQ:DISH) will also continue to provide consumers with alternative option.
How to Capitalize on the Merger
Since I am bullish on this merger actually going through I feel like there are several ways in which to capitalize on the deal.
· I think that the market is practically pricing in the fact that the deal will not go through. The current market price of Time Warner at $135 per share is only $2 above where the stock was pre-announcement. Assuming that prior to the announcement the market had fairly priced Time Warner's stock at $133, current valuations provide for limited downside. Time Warner has strong support at the $130 level. At its current price point with $133 being the pre-announcement starting price, I see only $2 - $3 in downside until arbitrators come in. Now, compared to the amount of upside $10 - $12 ($145 - $147 at Comcast's current price) I feel that going long this stock here is really a no brainer. I would suggest going long Time Warner here by either buying the stock outright or by buying some deep in the money call options.
· Since I always like to hedge my bets I would also go long Comcast at its current market price. Since the announcement the market has continued to sell off this stock, pushing it down almost 10% or $12.4 billion in market capitalization. I believe that the amount of further downside here is rather limited given that the market has already adjusted for the cost of merger. Additionally, if the merger fails to go through Comcast shares should bounce back quite a bit given how heavily discounted the price already is.
· As an additional hedge on this trade I would also suggest looking at buying and selling some options on the long Time Warner position to lessen overall exposure and downside risk. Assuming that you do either buy the stock outright or the deep in the money call options I would suggest selling some January 2016 160 calls and buying some October 2014 130 puts. This position obligates you to sell your long Time Warner position at $160 if/when the stock hits that point over the next 18 months. Since $160 strike is basically the acquisition price the amount of further upside after $160 I feel is rather limited.
In the event that the deal does not go through I suggest using some of the January 2016 call premium to buy some October 2014 puts at the 130 strike. That way if the market does further push down the shares of Time Warner and it falls below the $130 level, which I would consider support at this point, you have some protection on your long position.
Lastly, keep in mind that if the merger goes through, but Time Warner stock fails to reach the $160 strike the short January 2016 call option will most likely be converted over to a short January 2016 Comcast call option at the $55.65 strike (assuming the 2.875 ratio).
The strategies that I outlined above are fairly conservative with what I would consider a strong overall risk/return ratio. Admittedly the third strategy is bit fancier, especially for those not as familiar with options. Given the amount of volatility and risk premium being priced into both the stock and option prices it's hard not to capitalize on both simultaneously.