Will Fox's Time Warner Bid Set Off a Wave of Megadeals?

Rupert Murdoch

"The media M&A merry-go-round begins," says one analyst as industry observers discuss possible buyers and sellers.

News of 21st Century Fox’s rejected $80 billion bid from Time Warner comes at a time when an increasing number of Wall Street observers have predicted that big Hollywood players could become more aggressive in the hunt for acquisitions.

They have cited the financial strength of entertainment companies and recent divestitures that have focused them on core content businesses — such as Time Warner’s spinoff of Time Inc. — as well as recent consolidation among pay TV giants, such as the planned Comcast-Time Warner Cable deal, Charter’s proposed purchase of some cable systems from that merged entity and AT&T’s planned acquisition of DirecTV.

“Mergers are playing an important role in shaping the media landscape,” Janney Montgomery Scott analyst Tony Wible said in a recent report. “We believe the consolidation will continue and shift toward the content companies that will seek to balance out changes in purchasing power. An over-the-top induced deterioration in ad revenue growth [amid the continued growth in online video services] and increases in content costs make the TV networks more dependent on collecting larger increases in affiliate fees, which is jeopardized by [pay TV] consolidation. This is the impetus for TV network consolidation.”

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He said that deals were especially likely among “the smaller/independent names, such as AMC Networks, Starz, Madison Square Garden and [Hallmark Channel owner] Crown Media.”

In a Wednesday report entitled “The Media M&A Merry Go ‘Round Begins,” MoffettNathanson analyst Michael Nathanson described the rejected Fox bid for Time Warner as the opening salvo in a possible megadeal shootout.

“Having watched cable and telecom go through a full year of M&A speculation and, ultimately, consolidation, it is now the media sector's turn,” Nathanson said. “The idea of consolidation should come as no surprise; when one side of the bargaining table gets bigger the other side usually reacts.”

But he did express some surprise at the news of the offer. “We just never thought that 21st Century Fox (or Disney or CBS) with their broadcast network and vast scale would feel the need to react this soon, this aggressively and this big,” the analyst said.

Anthony DiClemente, analyst at Nomura, struck a similar note. “While media content consolidation has been widely discussed for some time, on the heels of the AT&T-DirecTV and Comcast-Time Warner Cable agreements, this is the first significant media content merger news between two large-cap conglomerates.”

Wednesday’s rise in big-name entertainment stocks showed that investors also see the potential for further deals.

With Time Warner on Wednesday saying that its existing business plan was superior to any takeover proposal Fox could put together, some industry observers suggested that the rejection didn’t have to be the end of the deal roulette, as Fox could instead hunt for other cable network groups. “If Fox finds TW attractive, surely Rupert [Murdoch] would see similar industrial logic in pursuing other cable network names, including Discovery Communications, Scripps Networks and AMC Networks,” DiClemente said. “This logic also holds true for small or non-U.S. film/TV studio companies.”

But some observers mentioned that the CEOs of big entertainment companies have thus far mostly said they are comfortable with their current scale despite pay TV combinations. DiClemente also emphasized that “we do not believe that media companies necessarily need to consolidate in order to ‘reclaim’ balance of power from now-consolidating distributors, such as AT&T/DirecTV and Time Warner Cable/Comcast.”

But he added that “it is undeniable that scale in sports and cable networks could incrementally bolster the negotiating power of content providers.”

Some argue that even the talk of one proposed and rejected deal could lead competitors to consider their own acquisitions. Among the combinations that Wall Street folks have recently suggested, or mentioned as possibly attractive on Wednesday: Disney-Discovery, Discovery-Scripps Networks, a big entertainment conglomerate buying smaller network groups such as AMC Networks or Starz, and a reunification of Viacom and CBS Corp.

Sterne Agee analyst Vasily Karasyov released a note to investors Wednesday about AMC Networks, saying “we would like to highlight AMC, which is positioned to benefit from the news flow” around the Fox offer for TW.

Calling the firm a “bite-size pure-play cable networks company at a $4.4 billion market cap,” he said “an argument for revenue synergies with a bigger programmer can be made.” Among other benefits, increasing the share of original programming could accelerate advertising revenue growth, while on the carriage fee side “being part of a larger group could help with leverage vis-a-vis distributors,” Karasyov said. Arguments against a sale include the control by the Dolan family, he added.

Even technology giants were name-checked Wednesday as possible suitors of entertainment companies. “At some point, technology companies such as Google or Amazon or Apple may begin to identify the value of professional content, and rather than license that content, they may attempt to acquire a media content company,” explained DiClemente. “Given its investments in Google Fiber, Chromecast, YouTube, and Google Play platform, it seems YouTube wants to get involved in the living room.”

Barclays Capital analyst Kannan Venkateshwar, meanwhile, sees a bigger likelihood that pay TV or telecom giants will look to buy content firms. “Although we believe that some content providers over the longer term will likely have to consolidate to get the scale advantage vis-a-vis the distributors, we think that horizontal consolidation is unlikely to provide the same benefit to content providers as the distributors,” he said in a recent report. About 50 percent of entertainment firms’ costs are for programming, he explained, a cost that doesn’t change much with scale.

Wall Street observers also said that Chinese or other foreign entertainment or technology companies could take a look at Hollywood companies amid all the deal talk.