By Parke Shall
By now, investors are aware that AT&T has announced a formal bid for Time Warner (NYSE:TWX). Speculation had been rampant during the trading week last week, but the market finally got some semi-definitive news on Friday when it was reported that not only was AT&T looking to make a bid for Time Warner, but that the bid could come as soon as Sunday night and that it would value the company between $105 and $110 per share in cash and stock.
On Saturday, the news broke officially that AT&T had bid $107.50 per share for TWX in a half cash/half stock bid.
Time Warner rose about four dollars in after hours trading on Friday, closing at about $92.50 for the week. This would represent a relatively meaningful spread for the proposed transaction, yet we do not think that chasing the arbitrage here is a good strategy. We wanted to write this article to briefly explain why.
The proposed merger is simple to understand from AT&T's perspective. AT&T, which already owns DirecTV, is looking to add and secure content as a giant secular shift from traditional cable to streaming continues to take place. It is a shift that we wrote about in our last article about Netflix and it is a shift that we wrote about just days ago when looking at Google securing a partnership with CBS for its WebTV service. This is certainly not a coincidence. Content is king right now and getting your hands on premium content is the name of the game as the world moves to a streaming environment.
By securing the purchase of Time Warner, AT&T gets its hands on Warner Bros. Studios as well as networks like HBO, both of whom have good distribution ties and a portfolio of content that has grossed billions in revenue over the last year. AT&T likely hopes to incorporate smart phones with their content as traditional TV viewing is really no longer what it used to be. Many people find themselves streaming their shows or events on their computers or on their smart phones, and as smart phones grow in size and tablets get smaller, these areas gray even further. AT&T clearly wants to be a company that can deliver what it is you want to watch to the preferred device that you want to watch it on at any time.
So what is a nearly 20% arbitrage in the stock price telling us?
We think it is telling us a few things, and we think that the market is right in being skeptical and not pushing TWX higher. Here's why we would not go in and be buying TWX on this news,
- First, the official bid price wasn't on the high end of estimates, which were as high as $110/share late last week.
- Second, the fact that the merger is being proposed in 50% cash and 50% stock leaves the market skeptical. Arbitrage investors traditionally prefer all cash deals.
- Third, the regulatory environment for such a merger is likely going to be very harsh. When regulators approved the NBC and Comcast deal, many provisions and amendments to the deal needed to be made in order to receive regulatory approval. AT&T is a massive company that already owns DirecTV. While it is easy to make the argument that Time Warner is more about content and DirecTV is more about distribution, you could also make the argument that Time Warner is also about distribution. When questions like these come up, provisions and changes will have to be made to satisfy regulators to approve pushing this merger through.
- Finally, this merger is going to take a significant amount of time to close. If they get regulatory approval and if the deal is announced, it is likely going to be at least a year before this transaction actually closes. The process of a merger is notoriously slow, but it becomes much slower when you are dealing with two companies of enormous size that are going to face potential regulatory scrutiny. The discount in shares of TWX probably already fairly reflects the amount of time that investors will have to keep capital occupied in order to collect the full spread on the arbitrage.
For these reasons, it doesn't make sense for us to go in and try to own TWX stock and wait out this merger. While the prospect of making a good-looking annualized return in relatively short order due to a larger than normal arbitrage is enticing, we don't find it to be a prudent use of capital over the course of time and we don't want any part in trying to capitalize off the spread.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.