AT&T bought TimeWarner (“TWX”) for $85 billion on October 22 – or at least it will if the U.S. government approves the deal, which is hardly a slam-dunk (though maybe a lay-up under a Donald Trump administration). AT&T shareholders were not amused – their stock price fell 7% in the wake of the announcement of the deal. While it’s not uncommon for an acquirer’s share prices to fall after a big acquisition (in fact, it’s common and supported by numerous empirical studies), 7% is a big number.
But I’m not going to focus on that aspect of the deal here. To me, the interesting narrative for this deal is that TimeWarner rejected an $80 billion offer From FOX back in 2014. I argued then in a newsletter to which I no longer have publication rights that the $80 billion deal seemed light because it offered no premium for obtaining a controlling interest. The market has indicated clearly that it’s time to re-think that position. Either a) the market has priced in a high likelihood of an acquisition for some time, or b) somehow, TimeWarner has been overpriced in the market by at least 20% (a typical, if conservative discount for minority interests). A little of column (a) and a little of column (b) are likely at work here.
Here’s the chart of TWX’s stock price since Rupert Murdoch’s bid:
Since FOX’s bid (that was quickly rejected), TWX’s stock price dropped, recovered for a bit as the market expected more M&A bids (which never came – even Murdoch stayed away, which was shocking to me). When those bids failed to materialize in mid 2015, TWX’s stock price slumped again and only recovered its footing when rumors of the AT&T deal surfaced and was finally agreed.
Here’s where we find out if you are a glass half-full or glass half-empty person. The half-full investor is happy they at least get a second chance at an M&A deal at more or less the same price as before – even a bit better. Basically, they got off the Titanic and found a lifeboat. The half-empty investor says, “Hold on – I held on to this stock for 26 months and I got an annualized return of 2.7%. That’s a lousy return.” Those investors are upset that the “unsinkable ship” sank. Granted, the S&P 500 return over the same period was only 3.6%, and that’s lousy, too, but 90 basis points’ better return on a fully diversified portfolio still beats what TWX did any day of the week (returns were adjusted for dividends – Source: Yahoo! Finance). The acquisition by AT&T is a capitulation by TWX’s management, any way you slice it. There was no apparent bidding war, and TWX at least salvages value much better than, say Yahoo! did after famously spurning the offer from Microsoft several years ago. (Apparently, Microsoft’s offer to throw in several free copies of Windows Vista failed to seal the deal.) If you’re a capital asset pricing model (CAPM) person, the news is even worse if you were long TWX. TWX’s beta is around 1. Where long-term treasury bill rates are around 2%, and the equity risk premium is 6%, the expected return on TWX is 8% per year, or a little over 16% in 26 months. In other words, for the risky roller coaster ride that Time Warner took its shareholders on, those shareholders were compensated for risk at about 30 cents on the dollar). An investor who had $1,000 in TWX in 2014 wound up with about $1,005 after 26 months. The risk that investor took ought to have been at $1,016.
How did Time Warner become such a lousy investment? I think two forces were at work. 1. TWX’s management misread their desirability in the market. They must have thought that an initial bid by Rupert Murdoch would have begotten additional bids, both from Murdoch himself and other parties. I must admit that I was a bit surprised myself that Murdoch made a sort of “hit and run” bid. One bid, one rejection, and crickets. The market priced in an acquisition, and when it failed to materialize, investors dropped the stock like a hot Galaxy Note 7. 2. TWX had some notion that they had the wherewithal to withstand the crushing forces that are confronting the conventional media industry. CNN is pretty much watched only by the elderly in between Matlock re-runs. Cord cutting is real. And we aren’t even sure what news is anymore. Judge for yourself how they did:
The chart pretty much speaks for itself. After a nice bump in Q4 2014, TWX’s revenue was stagnant or even slightly falling. In fact, it is entirely possible that TWX forecasted its Q4 2014 revenue and figured that would be a launching pad to new heights, and that’s why they turned down the Fox bid. As it turns out, Q4 2014 was the high mark in revenue. TWX’s management ultimately realized that they had bought into a mirage and found someone (AT&T) to bail them out.
I have to admit that I’m dying of curiosity on one front – once TimeWarner’s management realized that they had screwed up, did they consider going back to Mr. Murdoch and ask if he’d consider discussing the purchase? I’m guessing the response would not have been that charitable. And, if so, what was his response, or what would it have been? FOX has the National Football League, Major League Baseball, MLS Soccer, and The Simpsons. TimeWarner has Game of Thrones through HBO. And HBO’s special spot in the TV market is being rapidly dissolved by Netflix, Hulu and Amazon as they have created some terrific proprietary programming. TWX needed FOX more than FOX needed TWX.
The object lesson here is to know when you’re licked – as a founder or as an investor. TimeWarner thought that they had a viable option to being acquired by FOX but they were flat-out wrong. TimeWarner was fortunate that someone else gave them the same deal they could have had 2 years previous, but that still added up to effective loss (on a risk-adjusted basis) for the investors who stuck it out. Waiting 2 years to get the same deal you could have had the first time around is not a win. TimeWarner certainly fared better than did Yahoo after spurning an offer from Microsoft, but they still cost their investors money by thinking they were more valuable than they are. It’s hard to admit – and I imagine doubly so as the CEO of a publicly traded corporation – but sometimes your time is just up and someone else needs a turn. Sometimes you just are who you are.