Fox's Play for Time Warner: Pros and Cons of the Takeover Bid

5:00 AM PST 07/17/2014 by Georg Szalai
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Rupert Murdoch

Time Warner's board seems intent on going it alone, and a regulatory review ‎would be tough, but some analysts see factors that could still lead to a deal.

With Time Warner and Rupert Murdoch's 21st Century Fox on Wednesday confirming that the latter recently offered to acquire the former for $80 billion but was rebuffed, what's next for the two companies?

While some observers say nothing is likely to happen, at least not anytime soon, others predict Fox‎ will continue to pursue Time Warner, given Murdoch's reputation for not giving up easily.

Here is a look at some of the factors that make a deal challenging — and others that could facilitate an agreement down the line.

Relationships:

Relationships between the top executives of potential partners are always key and can make or break deals.

Time Warner CEO Jeff Bewkes and 21st Century Fox president and COO Chase Carey are friendly. They were seen having lunch together in the spring and reportedly met to discuss Fox's plan to submit a takeover offer for Time Warner.

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Also, former Murdoch communications chief Gary Ginsberg has been working for Bewkes in recent years. Both relationships suggest lines of communication that could help in deal talks should they restart at some point.

Business benefits:

Analysts see a combination of financial and strategic benefits in key areas. "Fox and TW together could have a greater opportunity to shape the video ecosystem globally and may have an opportunity to better leverage sports content," said Morgan Stanley analyst Benjamin Swinburne.

"This merger would create a cable TV network juggernaut," echoed Nomura analyst Anthony DiClemente. "Negotiating the affiliate rates of Fox News, FX and the Fox regional sports networks alongside those of TNT, TBS and others would heighten affiliate fee leverage." He estimates that the combined company could ensure 10 percent-plus carriage fee increases for the next five years or more.

DiClemente added that on the studio side the combination would "create incremental global scale/leverage" and that the combined company would have "enormous" international cable networks scale, creating synergies in ad sales, carriage fees and reach.

With Time Warner not owning a major broadcast network, a deal would also not create major regulatory worries on that front, many argue, even though some suggest the merged company may decide to or be forced to sell off TW's 50 percent stake in The CW.

Price-tag upside:

Sources said Wednesday that Fox could well sweeten its bid for Time Warner, which could also cause big institutional investors to pay close attention and possibly support a bid.

"We wouldn't be surprised should Fox come in with a different offer — either in price or in structure or both," said Wells Fargo analyst Marci Ryvicker. Her reference to "structure" means that Fox could offer more cash and less stock in a potential updated offer.

"With the cost of debt so low for the cash-financed portion of a transaction, the deal would be very accretive to both earnings per share and free cash flow," said DiClemente, arguing Fox has room to pay up. He estimates that at the initial $85-per-share offer, the deal would add at least 10 percent to estimated 2015 earnings. His conclusion: "Fox can pay over $100 per share and have the deal still be accretive."

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Still, DiClemente said, Fox may not be able to "bring enough cash to the table" for a deal that TW could accept given that TW's board has said it is confident in its outlook and position as an independent company. "Fox would have to up the offer to a level that compensates TW for the operational, regulatory and strategic risks," the analyst concluded.

Time Warner says it feels good about its future as an independent company:

"The board is confident that continuing to execute its strategic plan will create significantly more value for the company and its stockholders and is superior to any proposal that 21st Century Fox is in a position to offer," Time Warner said Wednesday.

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It added: "There are considerable strategic, operational and regulatory risks to executing a combination with 21st Century Fox."

All that signals TW is happy continuing as an independent company unless someone offers a big enough amount.

Bewkes has often highlighted that he is running TW with an eye on shareholder value, so a high enough price — some analysts say around $100 per share — might entice him to agree to a deal. Others even suggest that his recent slimming down of TW is a sign that Bewkes is willing to sell, but holding out for the highest bidder.

Murdoch, for one, has often paid full value or overpaid in deals to get his hands on assets he views as strategic. Said one observer: "This isn't over yet." 

Excessive scale:

Wunderlich Securities analyst Matthew Harrigan had an unusual concern about a possible combination — it could create a company that is too big to be successful.

"In our view, the combined TW and Fox would almost have excessive scale in certain businesses for optimal creative execution," he said in an investor note.

Explained the analyst: "A creative company, unlike a distributor like Comcast, can actually get too large from our view and possibly Washington's." He added: "We think the creative challenges of managing the huge TV production and film market shares at Fox and Warner Bros. would tax even the best management team."

Opposition and regulatory scrutiny would be intense:

Murdoch and other media moguls are often seen as controversial, polarizing figures. So many on Wall Street say Murdoch critics would raise their voices and concerns about a mogul-led conglomerate controlling so many entertainment assets and create political and PR hurdles for a deal.

Analysts have in the past mentioned that opposition to one company's ownership of two news networks would raise red flags in Washington. But Fox, which owns Fox News, would sell CNN in case of a deal, which would do away with one key concern.

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Beyond the sale of CNN, there is risk of other regulatory requirements, according to analysts.

"While we see regulatory hurdles as manageable, there would likely be conditions in this fairly aggressive regulatory environment," said Swinburne.

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Said DiClemente: "It is possible that regulators would require other concessions as well, some of which are hard to foresee." He said such concessions "could limit the affiliate and revenue synergies."

Guggenheim Securities analyst Michael Morris explained how the size of a combined company could raise concerns among regulators. "From a concentration perspective, we estimate that Warner Bros. and Fox combined would have accounted for $2.93 billion in domestic box office receipts in 2013, or 27 percent of the total market," he wrote. "For comparison, the next largest studio, Disney, accounted for 16 percent of total receipts." That could concern regulators.

Morris said the market power of a combined firm could also raise red flags in other areas. "The combined cable networks (ex-CNN) would account for almost $15 billion in annual domestic cable network ad revenue in 2014, approximately 30 percent of the total industry," he highlighted. "On an affiliate-fee basis, we estimate that the combined companies would earn almost $16 billion in 2014 or approximately 40 percent of the combined industry."

Email: Georg.Szalai@THR.com
Twitter: @georgszalai

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