The second largest U.S. national carrier AT&T (NYSE:T) has made a $48.5 billion acquisition proposal to pay-TV provider DirecTV (DTV). The basic intention of the deal is to effectively compete with the likes of Comcast (NASDAQ:CMCSA), which has a $45 billion pending merger deal set with Time Warner Cable (NYSE:TWC). But the question that arises is, how beneficial is the AT&T acquisition proposal? Several have concerns about the impact of the proposition on the merged entities and the stakeholders at large.
The pretty picture
While both AT&T and DirecTV portray that the merger would bring enormous benefits to customers and investors, many analysts are actually not convinced with this. In a press release, the two companies confidently said that the combination would produce a "content distribution leader." DirecTV CEO Mike White said that consumers would have wider options to choose from various competitive bundles.
There's no doubt that the deal would lead to cost synergies. Annual cost savings are expected to be around $1.6 billion, which is significant considering that pay-TV services are expensive. There's again no question regarding the fact that the two together would serve 26 million customers, as against Comcast-Time Warner's 30 million. The Dallas carrier in isolation wouldn't be able to give strong competition to the pay-TV leader Comcast.
AT&T CEO Randall Stephenson said that through the combination, the company aims to offer premium content that can be accessed through several devices such as tablets, smartphones, laptop and television. All this presents a pretty picture. So what's the ugly side?
The ugly picture
AT&T is speaking of economy with wider choice. The irony here is that consumers staying in the zone where U-verse operates would have lesser choice. And lesser options mean higher rates. For at least 25% of the U.S. homes, the merger would reduce the options for video providers from four to three - not something that the Federal Communications Commission (FCC) and the Department of Justice (DoJ) propagate. Such situations make matters difficult for budget users in particular, who seek services at reasonable prices. Lesser service providers cause concern to the regulators too as chances of charging higher prices rise.
This is the same reason why the watch dogs are skeptical about the Sprint (NYSE:S) and T-Mobile (NASDAQ:TMUS) deal. They believe that an industry needs at least four players to remain healthy and competitive. Any number lesser than that draws huge attention and antitrust scrutiny. All the biggies, particularly in the wireless sector, are criticized of misusing their position by charging exorbitant rates. Both Verizon and AT&T are condemned for their virtual telecom duopoly. Higher prices and entangling subscribers in a two-year contract are among the top practices that attract criticism. However, there's no doubt that their service and coverage is unrivaled by smaller players.
So the same fear lingers in the pay-TV segment as well. Reduction of the number of operators could be detrimental for customers. In the past couple of years, companies are making merger proposals at an alarming rate with the promise to make economical offerings to customers and better returns to investors through synergies of combination.
Another essential part of the proposed deal is that AT&T shall assume DirecTV's debt of $19 billion. If we rack our brains, we know sometime down the line the increased debt burden would hit consumer pockets. Though AT&T and DirecTV have expressed their neat intentions of making the best of offers, upgrading technology and gaining efficiency, it remains to be seen how much of it would be achieved after the acquisition.
With multiple merger proposals on the table, it's a big task for the FCC and the DoJ to uncover the actual plan or strategy behind the acquisition. Only after assessing the motive of the proposals, the regulator will be able to ascertain if the transaction will preserve competition and be in public interest. Of all the current merger deals, AT&T's and DirecTV's is the easiest to pass as TV isn't core to the former's business. In the other two proposed mergers (Sprint and T-Mobile, Comcast and Time Warner) the intention is to acquire players from the same industry, which invites greater discomfort to the FCC.
If things move in favor, the AT&T and DirecTV expect the deal to conclude within the next 12 months. Both the players have put their case forward saying that combination is the only way through which the joint company would be able to negotiate competitively with programmers. For AT&T alone, paying for content to provide service bundles in 22 states is a costly affair. The combination would enable the two to pose greater threat to the larger giants - Comcast and Time Warner.
What's in it for you?
While the pros and cons of the deal are known, what's in it for the investors? With the DirecTV merger in scene, are investors exposed to any risk? AT&T is known for giving the best of dividend yields. The carrier has always maintained a very high payout ratio that has delighted investors who have seen dividend grow even in years of lower earnings. The telecom major has a proud history of increasing its dividend every year.
Though high payout might look a bit risky at this point of time when the company is looking to acquire DirecTV, investors can put their fears to rest as the national carrier has been maintaining a solid free cash flow year after year. FCF for the fiscal year 2013 is $13.9 billion, that translates to $2.57 a share.
It should be noted that out of the $95 a share buyout, $28.5 a share would be paid in cash while the rest would be paid off in terms of stock. This implies that the company is funding the transaction partly by the cash it holds instead of raising debt that would call for interest payment and reduce returns to shareholders - an example of leveraging assets for optimum use. In addition, cost synergies from the deal should add to the company's profitability and increase earnings per share. Investors need not worry about the implications that the deal might have on their returns.
U-Verse is on a growth path, and at such a juncture merging with DirecTV would enable AT&T to solidify its existence in this segment. There's no denying that competition in the telecom market is intensifying with smaller rivals Sprint and T-Mobile, who are working hard to contend with larger players. So strengthening the other line of business to sustain future growth is a well thought out move of AT&T. With DirecTV's assistance AT&T would be able to penetrate remote areas and reach out to places that weren't earlier covered. Though there are several critics to the deal, I believe AT&T is thinking long and hard.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.