Our Thoughts On The Time Warner Cable-Charter Merger

Time Warner Cable (NYSE:TWC) and Charter Communications (NASDAQ:CHTR) announced Tuesday that they have entered into a definitive agreement for Time Warner Cable to merge with Charter. ^[1] Charter is a leading internet communications company and the fourth-largest cable operator in the U.S. As per the announcement, Time Warner Cable (TWC) shareholders will receive $195.71 per share, which represents a 14% premium to the stock’s May 22nd closing price. Charter will provide $100 in cash and the rest in shares of a new public parent company, tentatively called “New Charter”, for each TWC share outstanding. In this piece, we take a look at some interesting observations related to the deal.

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Industry Is Focusing On Consolidation

The TWC-Charter deal puts TWC’s enterprise value at $78.7 billion. ^[2] Charter had earlier agreed to buy Bright House Networks and this Syracuse based company will also be a part of New Charter. This deal is the latest to be announced in a cable communications industry that is undergoing a consolidation phase. European group Altice (OTC:ATCEY) recently agreed to buy a controlling stake in U.S. cable company Suddenlink for $9.1 billion, while the proposed $48.5 billion DirecTV (NASDAQ:DTV)-AT&T (NYSE:T) merger is currently under review and we expect it to be approved soon. ^[3] Time Warner Cable itself was initially set to merge with Comcast (NASDAQ:CMCSA). However, with all the regulatory uncertainty hanging over the deal, Comcast decided that the best course of action would be to drop the merger plans altogether. ^[4]

The pay-TV market has become saturated over the past few years. Even though total TV households in the U.S. have inched upwards, increasing from 114.2 million ^[5] in 2012-13 to 116.3 million in 2014-15, ^[6]  the pay-TV subscriber number has remained stagnant at around 100 million for the past few years. ^[7] Top pay-TV providers are currently losing a combined 100,000+ subscribers per year, having lost around 105,000 ^[8] and 125,000 ^[7] subscribers in 2013 and 2014, respectively. The decline has been hastened by the rise of alternative platforms such as online streaming services. Services offered by Netflix, Hulu, Sling TV and others offer engaging content and are comparatively cheaper that traditional pay-TV packages. The decline in the pay-TV subscribers has forced the providers to consolidate market share in order to reduce cost and unlock operating efficiencies. The rise in popularity of alternative platforms has also partly fueled the strong growth in the high-speed internet industry. High-speed internet service has become the most important part of the bundles being offered by the cable companies. Hence, these companies want to acquire their competitors in order to gain as much market share as possible in this lucrative industry.

TWC-Charter Deal Will Face Fewer Regulatory Hurdles

Since its announcement, the proposed Comcast-Time Warner Cable (TWC) merger consistently faced stringent opposition from the general public, industry players, as well as public interest and consumer-advocacy groups. There had been indications that the deal would find it difficult to get the required regulatory approvals, with staff attorneys at the U.S. Justice Department’s antitrust division stating that they were nearing a recommendation to block the deal, and the FCC staff recommending a procedural move that would put the merger in jeopardy. ^{[9] [10]} With these dissenting voices empowered, Comcast decided to walk away from the deal.

FCC Chairman Tom Wheeler issued a statement which made it clear why he was opposed to the merger. It was the potential power that the combined entity would have wielded in the high speed Internet market that worried him the most. The Comcast-TWC combine would have represented 37% of the high speed Internet market with TWC and Comcast accounting for 13% and 24% respectively. ^[11] The FCC had previously used 30% as a strict limit on the maximum allowable market share for one company. However, the TWC-Charter deal raises no such issues as the high speed Internet market share of New Charter will be under 21%. ^[2] Similarly, the Comcast-TWC combine would have accounted for approximately 30% of the pay-TV market while New Charter will account for only 17%. ^[12] Hence, the market shares for New Charter will remain below the 30% unofficial limit in both pay-TV and Internet markets, which could result in less scrutiny by the FCC.

However, there are certain other concerns which plagued the Comcast-TWC deal that are applicable in this deal as well. Critics pointed out that Comcast and TWC had traditionally been rivals and their merger would reduce choice for customers. Even though both these companies did not directly compete with each other and there was almost no physical overlap in their respective service areas, their business models were eerily similar and one of the main motivations behind the merger was consolidation of market share. Critics had also argued that Comcast could potentially use its considerable power in the broadband market to disrupt online streaming services. These streaming services have been slowly chipping away at cable pay-TV services for a while now and TWC, Comcast and Charter have all lost pay-TV subscribers as a result. These issues will once again be relevant when the FCC starts its review of the TWC-Charter merger. But the fact remains that New Charter will wield comparatively less influence than what the Comcast-TWC combine would have wielded.

The Merger Will Be Beneficial To Both Companies

Time Warner cable has said that the transaction will generate approximately $800 million in cost efficiencies every year. ^[2] Moreover, New Charter will benefit from the merger synergies, including combined purchasing, overhead, product development, engineering and IT. The merger could potentially have an impact on the rising content costs. The Pay-TV industry has been battling with content owners over distribution agreements for the last few years. An increase in carriage fees directly impacts the end customer as cable companies tend to pass on these costs to their subscribers. If the merger goes through, New Charter would be the third largest cable operator behind the potential AT&T-DirecTV combine and Comcast. Consequently, the combined entity will gain significant leverage on the distribution front. In terms of broadband, both Time Warner Cable and Charter Communications need to further enhance their systems in order to compete with the newer technologies offered by Comcast, AT&T and Verizon. A consolidation can help these companies in mobilizing the necessary capital by combining their CapEx. Additionally, the merger would lead to tax efficiencies as Charter Communications’ net losses can act as a tax shield for the new entity.

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1. Charter Communications to Merge with Time Warner Cable and Acquire Bright House Networks, May 26, 2015, Time Warner Cable Press Release [↩]
2. Time Warner Cable’s SEC Filings [↩] [↩] [↩]
3. Altice Looks to U.S. After Sealing Suddenlink Deal, May 20, 2015, Wall Street Journal [↩]
4. COMCAST/TIME WARNER CABLE/CHARTER TRANSACTIONS TERMINATED, April 24, 2015, Comcast Press Release [↩]
5. NIELSEN ESTIMATES 115.6 MILLION TV HOMES IN THE U.S., UP 1.2%, May 7, 2013, Nielsen [↩]
6. NIELSEN ESTIMATES 116.3 MILLION TV HOMES IN THE U.S., UP 0.4%, May 5, 2014, Nielsen [↩]
7. MAJOR PAY-TV PROVIDERS LOST ABOUT 125,000 SUBSCRIBERS IN 2014, March 3, 2015, Leichtman Research Group [↩] [↩]
8. Major Multi-Channel Video Providers Lost About 105,000 Subscribers in 2013, March 14, 2014, Leichtman Research Group [↩]
9. U.S. Antitrust Lawyers Said Leaning Against Comcast Deal, April 17, 2015, Bloomberg [↩]
10. FCC Staff Recommends Hearing on Comcast-Time Warner Cable Merger, April 23, 2015, Wall Street Journal [↩]
11. NEARLY 1.2 MILLION ADDED BROADBAND IN THE FIRST QUARTER OF 2015, May 15, 2015, Leichtman Research Group, Inc. [↩]
12. MAJOR PAY-TV PROVIDERS ADDED ABOUT 10,000 SUBSCRIBERS IN 1Q 2015, May 14, 2015, Leichtman Research Group, Inc. [↩]