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Regulatory Concerns, Limited Accretion Make AT&T-Time Warner Deal Risky

T | October 24, 2016

Deutsche Bank believes the key risks to the AT&T Inc. (NYSE: T)’s takeover of Time Warner Inc (NYSE: TWX) are increased regulatory scrutiny and limited near-term accretion/synergies.

AT&T said it would buy Time Warner for $107.50 per share in a cash and stock deal, which has a total equity value of $85.4 billion. The deal combines Time Warner's vast library of content with AT&T's extensive distribution network.

The deal is set to face regulatory hurdles given the deal size, and AT&T’s distribution scale. Notably, large scale M&A’s such as Comcast’s attempt to buy Time Warner Cable and AT&T’s effort to buy T-Mobile has been thwarted by regulators.

“While T/TWX is a vertical integration (these deals have usually cleared, and this may not be subject to FCC review), we see major regulatory pushback, especially as this comes just one year after T/DTV cleared,” analyst Matthew Niknam wrote in a note.

Further, Deutsche Bank’s M&A model shows limited near-term accretion (low-single digit percentage) on an EPS/FCF basis.

“It’s also worth noting long-term synergies are ~5 percent of TWX opex, which compare to ~10 percent targeted for DTV and 15–20 percent for traditional telco deals where T had more cost overlap,” Niknam highlighted.

Moreover, the analyst noted that there is limited precedent of a successful marriage of distribution and content in the US. The analyst also pointed out the AT&T’s debt load of $180 billion, which may restrict the carrier’s ability to spend capital beyond deleveraging.

“Given the FCF generation inherent in TWX’s business, our pro forma does imply AT&T’s dividend payout ratio will drop to ~60 percent by Year 3 post deal (200–300bp below our standalone T model),” Niknam noted.

Among the positives, Time Warner brings high quality content such as HBO, TBS/TNT and Warner Bros. in to AT&T’s fold, giving it an edge over rivals and overcome the threat of cable companies entering the wireless space. In addition, AT&T has very low downside risk in this scenario given a $500 million break fee (just $0.08/share).

Niknam has a Buy rating on AT&T, with a price target of $45.

Shares of AT&T closed Friday’s trading at $37.49 and Time Warner closed at $89.48. In the pre-market hours Monday, both shares were down by 2.5 percent and 1.05 percent, respectively.

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