For the past month, the media and financial worlds have been fixated on the potential 21st Century Fox (NASDAQ:FOXA) purchase of Time Warner (NYSE:TWX). Time Warner previously rebuffed an $85 offer, saying the bid undervalued its assets. Fox's Rupert Murdoch is known for his persistence once he finds an asset he wants, and it was widely expected that he would find a way to increase the bid. This backdrop made Tuesday's breaking news all the more stunning. After the bell, Fox announced it was withdrawing its offer to acquire TWX (press release available here).
While Murdoch thought a deal made strategic sense, he said, "Time Warner management and its Board refused to engage with us to explore an offer which was highly compelling." Time Warner's management refused to even discuss a possible deal with Fox, Murdoch was unwilling to bid against himself without some cooperation from TWX. Instead, Murdoch plans on repurchasing up to $6 billion in FOXA stock. On this news, FOXA soared 8% while TWX plummeted 11%. I expect TWX shares to fall even further. Before the bid was announced, TWX was trading around $71, 5% below where it was trading after the bell. This remaining deal premium is unmerited as Fox is clearly moving on, focusing on a share buyback instead. Now is not the time to buy Time Warner.
Moreover, existing Time Warner shareholders should be absolutely infuriated. Fox made a very compelling bid for the company, valuing it at 12.6x EBITDA, which is attractive for a media company with some strong but some weak assets. Now, TWX was an excellent fit for Fox. HBO is a power-house brand, and its HBO Go offering is the most credible challenger to Netflix (NASDAQ:NFLX) on the market. Adding Fox's library to HBO would make it even more compelling. Adding Time Warner's NCAA basketball and MLB content to Fox Sports would also have helped the company better compete with Disney's ESPN (NYSE:DIS). The DC Comics offers potential franchises that would complement Fox's current film properties, namely X-Men, Planet of the Apes, and its Dreamworks (NASDAQ:DWA) distribution deal.
Given these assets, there is nothing wrong with TWX management trying to get more than $85. However, they refused to even engage Fox, making it clear they viewed $85 as way too low, despite being a 20% premium to where TWX had been trading. Management clearly wanted Murdoch to bid against himself and pay at least $100, but Murdoch refused to bid against himself. By being greedy, Time Warner ended up with nothing. In reality, $85 was a fair offer as TWX's portfolio is far from perfect. Apart from HBO, its original programming is mixed, and it lacks a major broadcast network. Moreover while its film studio has been a leader over the past decade, major franchises are rolling off the books. The Dark Knight trilogy is over. The final Hobbit movie comes out this year while the company is trying to create a Harry Potter spin-off to make up for that lost revenue. While Disney has done an excellent job expanding the Marvel universe, TWX has been unable to expand DC Comics beyond Batman and Superman. Its lucrative co-production deal with Legendary has also come to an end. With these problems, 12.6x EBITDA is certainly a reasonable valuation.
There is nothing wrong with being a tough negotiator, but one has to be willing to negotiate. Time Warner totally misjudged Murdoch, taking him for a fool who would pay anything. Instead, he proved to be a disciplined buyer unwilling to overpay for assets that have strategic value but also problems. Now, investors in TWX have to hope its management can solve these problems and build new film franchises to accelerate growth and move the stock higher. I would wait for shares to TWX to trade below $70 or 15x 2015 earnings before buying as a merger is now extremely unlikely. Conversely, I would be a buyer of FOXA given the buyback and disciplined management. Time Warner's refusal to consider a merger will go down as a major strategic error.
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