Today’s Headlines: Charter to Merge with Time Warner Cable

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Today’s Headlines: Charter to Merge with Time Warner Cable
June 2, 2015

If At First You Don't Succeed, Try Again: Charter Acquires Time Warner Cable

In the case of Charter Communications (NASDAQ:CHTR), the second time appears to be the charm. After a failed initial attempt in 2013 to buy Time Warner Cable (NYSE:TWX), Charter bided its time until the proposed TWC merger with Comcast (NASDAQ:CMCSA) fell through last month, then moved in with an improved offer. Charter was able to fend off Altice SA (AMS:ATC), a telecom company based in Luxembourg that also was interested in purchasing TWC.

The nearly $55 billion deal announced on May 26th will form the second largest cable TV enterprise. "New Charter" will serve approximately 24.2 million cable TV customers, with the combined 15.4 million from TWC, 6.3 million from Charter, and 2.5 million from Bright House, which Charter has already agreed to purchase. Comcast is still the king at 27.2 million customers, but the merger would place the big two far above the next two competitors: Cox, with approximately 6 million customers and Cablevision (NYSE:CVC) with approximately 3.1 million.

Charter is paying $195.71 per share with $100 in cash and the remainder in Charter shares. Assuming regulatory approval, the deals involving all three parties are expected to be complete by the end of this year.

Smoother Regulatory Sailing

Given the regulatory scuttling of the Comcast/TWC deal, are regulators likely to undercut this deal as well? Most analysts think that New Charter will have a considerably easier time. The smaller size of the deal and the fact that Charter does not own any content providers defuses one of the major arguments against the Comcast/TWC merger — that streaming services competing with cable could be strong-armed or priced out of prized content by pressure from a large combined cable/content provider.

High speed Internet is less of a concern as well. The New York Times reports that the combined New Charter would control less than 30% of the broadband market, compared to Comcast's 57% (using the new 2015 definitions of 25 Mbps downstream/3Mbps upstream, which knocks slower DSL networks out of consideration).

The battle may be more with the Federal Communications Commission (FCC) than it is with the Justice Department, according to Gene Kimmelman, the president of the public interest group Public Knowledge and a former Justice Department employee. The smaller footprint of New Charter compared to the proposed Comcast/TWC merger should have little trouble dealing with an antitrust argument, but the FCC will need to see the consumer benefits — not just an “absence of harm.” FCC Chairmen Tom Wheeler stressed such a public interest test in a statement after the announcement of the pending deal.

Where is the public interest element? Improved customer service would be a great place to start. Out of 17 cable companies, Consumer Reports rated Charter and TWC the 14th and 16th best in customer satisfaction. The one company that was worse than TWC was Comcast.

Charter did specify improved customer service as one of the benefits during a presentation to investors. Faster speeds combined with lower prices, improved Wi-Fi connections outside of the home, and other yet-to-be-revealed innovations were also pitched as potential benefits.

The Return of the "King of Cable"

It may seem odd that the smaller company is buying the larger company. As of May 29th, Charter's market cap was at just over $20 billion while TWC's was at $51.2. Look to Charter's management for the answer. The driving force behind the acquisition strategy is John Malone, the former head of TCI, who is a minority investor in Charter as well as a board member.

There's a reason Malone was once known as the "king of cable." The New York Times has called Malone a "vocal advocate for industry consolidation," and that strategy makes a great deal of sense. In the current cable market, it's very difficult for smaller operators to attain sufficient leverage — thus, it's "eat or be eaten" for the little guys.

While transforming Charter into an industry colossus, this leveraged buyout leaves the company with quite a debt burden. They will be assuming approximately $22 billion in debt from TWC along with $2 billion from Bright House. Up to $30 billion more will be borrowed to finance the deal. Charter CEO Tom Rutledge acknowledged that the deal will produce a high debt to cash flow ratio (nearing 4.8), but declared it "reasonable."

Malone's Liberty Broadband, the biggest shareholder of Charter, will assist by purchasing $5 billion in newly issued Charter stock in increments once the TWC and Bright House deals close.

The Takeaway

Since New Charter will be below the rule-of thumb 30% market threshold for both broadband and pay-TV customers, it does seem likely that the proposed merger will pass the collective regulatory hurdles and be approved. We are skeptical that any of the proposed consumer benefits will come to pass — and if they do, we're skeptical that the merger is the main reason why.

Expect mergers and acquisitions to continue, because that's about the only possible way for cable TV and broadband business to grow. The amount of capital investment it takes to run cable through a large metro area provides disincentive for cable companies to compete head-to-head.

While the larger mergers are making headlines, smaller players are being snapped up as well. For example, Altice SA settled for purchasing the relatively small cable operator Suddenlink. Others are likely to follow.

Amy Young, media analyst with Macquarie, said, "You can imagine a scenario where you are going to have two large cable companies and two large wireless companies." Given that other large mergers and acquisitions are going across platforms, such as the AT&T (NYSE:T) acquisition of DirecTV (NASDAQ:DTV), that dividing line isn’t guaranteed either. The one thing that is guaranteed is that mergers are going to be continuing as a means of growth and acquiring leverage with content providers — to the extent the FCC and the Justice Department will allow.

The wave of mergers makes investing in cable TV, broadband, streaming services, or content providers a minefield right now. If you choose to dive in, research your chosen company very carefully. Look for any hints of a merger or acquisition that will either involve the company or its rivals, and whether the merged company would have sufficient mass in any one service, especially broadband, to increase the likelihood of regulators disrupting the deal.

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