Like most of you I'm sure, some days I daydream I'm an M&A investment banker...
Now that the AT&T (NYSE: T) – Time Warner deal has been approved, and an upcoming Disney (NYSE: DIS)/ Comcast (Nasdaq: CMCSA) – Fox (Nasdaq: FOXA) deal is on the horizon, there’s been a lot of speculation about what the next mega-merger could be in the technology, media, and telecom spaces.
The trend – for better or worse – seems to be to get big, and offer a comprehensive suite of services that can be “bundled” together. The advent of big data and A.I. also lends itself to size, where huge datasets and customers can be mined for supposed insights and greater ad targeting. Yes, Facebook went a bit too far in that regard and regulations might be coming, but I still think getting free/cheap services on the internet in exchange for relevant ads will be the way forward.
In the age of giant superstores Amazon (Nasdaq: AMZN) Prime, as well as Chinese internet conglomerates Tencent (NASDAQOTH) and Alibaba (NYSE: BABA), it is hard to argue with the logic that the “ecosystem” play is certainly a way to go these days; however, there could be limits exactly to how far the trend will go.
Since AT&T will now have the sweetener of free or discounted HBO to lure people into its wireless/cabe/broadband bundle, other triple-play competitors may feel the need to snap up more (or any) content. In addition, a recent TechCrunch article suggested that content companies may very well need to acquire or become ISPs (Internet Service Providers) in the age of non-net neutrality. The author's thesis is that bandwidth-hungry internet video content companies such as Netflix (Nasdaq: NFLX) or Google (Nasdaq: GOOG) may need to own an ISP in order to prevent their traffic from being throttled (by having the leverage to throttle HBO/ Time Warner content in retaliation). I’m not exactly sure that would happen (would you subscribe to an ISP with crappy Netflix?), but it’s definitely an angle to think about.
Still, we are all betting men and women here, and it’s fun to speculate. Recently, I’ve had moments where I fantasize that I’m an M&A banker, with all of the major TMT CEOs on my rolodex. Here would be the four proposals/ predictions I’d lay out going forward.
(Note: I have no information about any of these transactions and they are purely speculations. Please do not construe these as investment advice. I know nothing!).
Prediction 1: Facebook (or Verizon) buys Discovery
Discovery Inc. (Nasdaq: DISCA) is completing a recent merger of its own, buying Scripps Network last year (the deal closed in early 2018). Discovery now owns one of the larger libraries of non-fiction content such as Discovery, the Learning Channel, and Scripps’ HGTV and The Food Network. Discovery actually owns sports content in Europe as well with its Eurosport channel, which is broadcasting the Olympics throughout Europe in over 40 countries and multiple languages, in multiple formats (both traditional distributors, as well as over-the-top) through 2024. The company also agreed to a huge 12-year deal with the PGA Tour to make a global direct-to-consumer golf app, which I think could be hugely successful.
Prior to the merger, Discovery was earning roughly $1.4 billion in free cash flow, and HGTV was earning about $0.8 billion. In the past earnings call management signaled that they now expect the synergies from the deal will total $600 million, up from an initial target of $350 million. The combined companies now also control about 20% of the ad-supported female demographic, which I think also gives the combined company (which by the way is global – nature shows and gold can travel! – in 220 countries) a lot of leverage with advertisers and distributors as well. With the new PGA deal, I think the company can definitely hit its multi-year target of $3 billion in free cash flow put forward by CEO David Zaslav. Non-fiction content is MUCH less expensive, not subject to the crazy bidding wars going on for top talent among the Netflix's, Showtimes, and HBO's of the world.
At the current market capitalization of around $17.1 billion, that’s less than 6x that future free cash flow number (albeit in a few years).
Now the company is somewhat cheap for a reason – it is highly levered (4.5x OIBDA) and has been shedding some cable subscribers (like everyone else, due to cord cutting), but it has been manageable. Ad rates and affiliate fees have gone up, the company is still posting top-line growth growth. Discovery plans to get its leverage down to a target of 3.0-3.5 by end of next year, which should be feasible. I could easily see the company being taken out for a meaningful premium by, say, maybe a Facebook (FB) or Verizon Verizon (NYSE: VZ) .
Why would Facebook or Verizon be appropriate? Well, global, non-fiction, ad supported… all of those seem to highly align with Facebook to me. Facebook has also been looking to get into the content game for a while, with its Facebook Watch initiative. I would say, the jury’s still out on how that’s going… and that may be generous.
Buying Discovery would give Facebook immediate access to top-notch content creation and global reach. I’m not exactly sure what the synergies would be, but I assume there could be a lot of revenue synergies as advetisers target consumers on a global basis across TV, internet TV, and mobile, and Facebook/ Instagram. Also, the golf initiative could really fit in well with Facebook and Instagram’s photography angle and even their collective virtual reality efforts with Oculus.
If Facebook doesn’t go for Discovery, Verizon could be next in line. Verizon made a content play with the very 20th-century busted internet assets of Yahoo and AOL, and I think it could use a boost on the content side if it aims to be a serious player. Not sure if Verizon, with its debt load and need to build out its 5G network could necessarily afford it, but it could make for a decent suitor should no one else step up.
Prediction 2: Google buys CenturyLink
CenturyLink (NYSE: CTL) at just under a $20 billion market cap could also make a great buyout target – especially for Google, with its $100+ billion in cash it can now repatriate. Google could also combine its Google Fiber unit with the larger-scale Level 3 fiber assets that are now within CenturyLink, and with CenturyLink’s stock so cheap (down 50% from its price three years ago), Google could still likely pay a meaningful premium and still do well with the asset.
Google, as some may know, attempted to become an ISP itself with its Google Fiber unit “Other Bet;” however, building a national premium ISP is no easy feat, even for the search giant. In 2016, the company scaled back the effort, likely to focus on building out its Cloud offering which it hopes will compete with AWS.
CenturyLink/Level 3 also has a built-in customer base and also a large enterprise business, which now makes up the majority of the combined company’s revenue and earnings. Google would get an instant ISP (therefore mitigating throttling of YouTube by AT&T, should the TechCrunch author be right) and would also probably save a lot on interconnection fees with the CenturyLink/Level 3 global fiberoptic network. Combining Google Fiber and CnenturyLink could also give the company scale to compete meaningfully with the other telecom/MVNO giants.
On an interesting side note, CenturyLink recently released a press release detailing a new connection service with Google’s Cloud Platform. Hmmm…
Prediction 3: Comcast loses the battle for Fox and makes a bid for Charter
I still think that Disney (NYSE: DIS) will eventually win out in a bidding war for Fox’s assets – not 100% sure, as Disney may aim to go the other way, spinning off ESPN/ABC and shrinking down to becoming just the “pure” Disney brand. Still, I think if Disney really wants Fox (and the Murdochs clearly preferred Disney’s initial lower offering over Comocast’s intial bid), Iger & Co. should prevail.
Should that happen, Comcast may make another bid for Charter Communications (Nasdaq: CHTR) – I know, I know, the largest MVNO combining with the second-largest MVNO? How would that pass muster? Also, didn’t Comcast try to buy Time Warner Cable (now a part of Charter) already back in 2014, only to be blocked by regulators?
That's true; however, the ruling for AT&T-Time Warner, as well as the incredible rise of Amazon/Netflix/ Google and the accelerated cord-cutting that have occurred really only 2015, I think it's not crazy to think a renewed Comcast/Time Warner tie-up is at least a possibility.
While the two companies are the number one and two cable providers, their footprints do not overlap at all (of course, that was also the case two years ago). The two companies have also already teamed up to license their upcoming wireless offerings from Verizon, which should be rolled out this year.
This one may be unlikely due to the aforementioned regulatory concerns, but hey, Brian Roberts can dare to dream…
Prediction 4: Netflix merges with T-Mobile-Sprint
Finally, the least likely pairing, but one that’s not totally ouf the realm of possibility, could be a Netflix-T-Mobile-Sprint tie-up. I’m guessing Netflix could offer an all-stock deal (at its lofty price of nearly $400 per share!).
The thesis here is really back to the TechCrunch article: if ISPs start throttling Netflix. Netlfix is the largest bandwidth-user -- In 2015 (the most recent data I could find), Netflix accounted for 37% of all bandwidth traffic.
Should 5G become a viable technology sooner than I and others expect (I don't think it will be nearly as easy or quick to build out 5G as others do), it’s possible many wouldn’t even need fiber-based ISP or cable provider to get your internet. In that case, T-Mobile (Nasdaq: TMUS) could theoretically become a viable 5G-only ISP.
The main justification for the tieup would be:
- The companies already collaborate, with T-Mobile currently offering free SD Netflix for its two-line-plus customers, or a discounted $3 premium subscription (its own answer to AT&T’s upcoming HBO sweetener).
- John Legere and Reed Hastings are kindred spirits, both incredibly successful “disruptors” in their spaces and keenly attuned to what modern consumers want.
I’m not sure Reed Hastings would entertain a full-fledged merger – after all, the guy won’t even entertain expanding into sports or video-gaming – but I’m sure everyone on the T-Mobile-Sprint side would be dying to be affiliated with the most successful stock in the market and a beloved consumer brand.
Which of these four do you all think has the best chance? Let us know in the coments below, or feel free to propose a megamerger I haven't thought of!
Disclosure: I am/we are long T, TMUS, BABA, TCEHY, FB, GOOG, AMZN, CHTR, DIS, DISCA, CTL.
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