MSF 507: ADVANCED CORPORATE FINANCE May- Aug, 2023; (CAT) While the cable industry has always been subject to a high degree of acquisition activity, it has historically been used mostly as a mechanism for achieving and sustaining a high level of revenue and profit growth. More recently, cable firms have been engaging in acquisitions as much for survival as for growth. Acquisitions for the cable companies represent a much more rapid way of obtaining increased geographic coverage, customer contracts, as well as network and content assets than growth by reinvesting in their existing business. The major risk of acquisitions is overpaying for acquired assets and not being able to generate the minimum required return to attract and retain investors. In 2013, Charter Communications Inc. (Charter) made several offers for Time Warner Cable (TWC) but was repeatedly rejected. In 2014, it made an unsuccessful hostile bid but was thwarted by TWC accepting a richer Comcast bid. Charters aggressive tactics seem to reflect the instincts of cable mogul John Malone. He has substantial influence on Charters strategy through Liberty Broadband Corporations (Liberty) substantial equity stake in Charter. Malone is the controlling shareholder in Liberty. When Comcasts deal was thwarted by regulators, the highly leveraged Charter took a less aggressive approach getting Mr. Malone more involved in the initial phases of the deal. He called TWCs CEO Rob Marcus initially indicating that Charter wanted a friendly deal. Charter deliberately avoided making what would be perceived by TWC as an excessively low offer so as not to alienate TWCs CEO and board. Charters offer of $195 per TWC share was also structured to give TWC shareholders more choice: $110 in cash and $95 in stock or $115 in cash and the remainder in stock. The deal involved a breakup fee. If regulators block the deal, Charter could owe Time Warner Cable about $2 billion, or Time Warner Cable would be responsible for the breakup fee if it had accepted an offer from a rival suitor. Timing and persistence paid off. Charter announced on May 26, 2015, that it had reached an agreement to acquire TWC for $55 billion cash and stock deal excluding assumed TWC debt, a 14% premium to TWCs closing price on May 22. The merger also includes a smaller cable company, Bright House Networks, which Charter had previously agreed to buy. Liberty, the John Malone Company holding a stake in Charter, bought $5 billion in new stock to help finance the takeover. Including debt and equity, the transaction value (also called enterprise value) of TWC was $78.7 billion. The deal enables Charter to quadruple its number of cable subscribers, with much of the increase coming in such key cities as New York, Los Angeles, and Dallas. The combined businesses will have more than 24 million cable customers, second only to Comcasts 27 million. In addition, the combined firms will have greater leverage in negotiating contracts with television networks wanting to distribute their content to the new firms cable customers. TWC shares rose 7.3% on the deals announcement date, or about one-half of the offer price premium. Charters shares gained 2.5%. In the wake of the failure of market leader Comcast to get approval to acquire TWC, why did Charter believe it could get approval? There is little market overlap between Time Warner, Charter, and Bright House and the combined businesses will still not be as big as Comcasts broadband/cable business. By some estimates, a tie-up between Comcast and TWC would have given the combined firms almost two-thirds of the broadband market. Moreover, Charter is not as vertically integrated as Comcast that produces considerable amounts of its own content. The Federal Communication Commissions clearer definition of so-called net neutrality rules, which essentially ban discrimination against businesses wishing to access the internet through gateway services such as cable, makes it more difficult for a cable firm to hamper access to potential competitors. Finally, the emergence of online video alternatives to cable promotes increased competition for the traditional cable firms. In May 2016, Charter received regulatory approval to acquire Time Warner subject to certain conditions being satisfied. These include requiring Charter to expand broadband service in areas that are currently underserved and to provide affordable internet service to at least 525,000 low-income households. To be successful in the coming years, cable operators will need to lean heavily on their broadband businesses to generate profit growth while limiting shrinkage in their TV business. That means investing in broadband infrastructure, streaming video services, and other technologies. Consequently, the demands on cash flow will accelerate. The impact of the consolidation among cable providers on content providers is ominous. The Charter/TWC deal shrinks the number of major internet and cable TV distributors in the United States to just four: Comcast, Charter, Verizon, and AT&T/DirecTV. With fewer outlets to sell their shows, TV and cable network content providers have less leverage to demand high fees and the inclusion of their niche channels in packages of services offered to cable customers. This is likely to hurt revenue at content providers such as Discovery, AMC Networks, Scripps Networks Interactive, and even Viacom. Their only recourse may be for the networks to merge or be acquired by cable and internet distributors themselves. While content distributors may currently have the upper hand in their dealings with content providers, their advantage may be short lived as Amazon, Facebook, and Apple could enter the business of providing streaming video on demand. This would enable the major TV networks to seek partners from firms such as Facebook or Apple when they launch their own internet-based video service. The cable companies turned online video and broadband suppliers must remain vigilant and aware of changing circumstances in the industry. A clear vision of where they want to compete and on what basis they want to compete will help sustain their advantage over content suppliers. However, as technological and regulatory change occurs, they must be willing to vary their business models to accommodate changes in their external environment. Discussion Questions: a) Discuss the logic underlying the mergers and acquisition motive(s) in the case above. b) Explain the possible reasons why Charter offered Time Warner Cable a choice of various combinations of stock and cash. c) Charters share price gained by 2.5% while Time Warners share price jumped by 7.3%, about one-half of the offer price premium. Discuss the reasons why the stock prices of the two firms acted as they did immediately following the announcement of an agreement between the two firms to merge. d) What factors contributed to able industry consolidation? Explain how each factor identified impacted industry competitors