Decker Anstrom’s favorite philosopher, Yogi Berra, could have been describing the activities of Dr. John Malone when he said "it’s déjà vu all over again." Just as he augmented his cable assets in the 1990s, Malone is accumulating sports programming for DirecTV in what some see as a not-so-instant replay of the strategy he used to build TCI into the cable powerhouse he sold to AT&T for $54 billion.
Malone, they say, will follow his old TCI playbook: wedding distribution with exclusive programming, piling on debt to minimize taxes, then seeking a buyer to provide a lucrative, tax-efficient cash-out. Others expect him to pursue a longer-term strategy to combine sports programming and HDTV to give cable an ongoing run for its money. Malone’s path is among several $64,000 — $10 billion really — questions looming over the media ownership landscape.
The Basics: A ‘Triopoly’ and More Consolidation
"It appears we’re headed for a triopoly," Merrill Lynch media analyst Jessica Reif Cohen says. "It’s either going to be Comcast or Time Warner in the major markets versus Verizon or AT&T," and then "obviously EchoStar and DirecTV."
Consolidation among the multichannel distribution systems is just one set of pieces in the dynamic Rubik’s Cube that is media ownership. As technologies, markets, products and services converge, the frenzy of mergers and acquisitions will continue unabated, observers say.
Led by newly independent Time Warner Cable — with cash reserves and its separate stock now available as currency — MSOs will continue to buy, sell and swap systems to further consolidate and create scale, while the telcos and satellite systems look for acquisitions and allies to help blunt the challenge of cable’s triple play. Programmers — in a borderless digital age where content is king — will coalesce around a handful of powerful brands with potentially global reach.
"It continues to be a time that is ripe for consolidation," notes UBS managing director/senior analyst Aryeh Bourkoff, "because interest rates are low, and you have an election coming up, so there is a little bit of a rush to engage and close merger activity before we get into a more uncertain period." Private equity money devoted to telecom, media and technology has tripled in the last year, a major stimulant of consolidation, he adds.
But it’s not necessarily a gloomy scenario for cable owners. MSOs as well as smaller, independent cable systems could see their value rise, particularly those within and adjacent to the footprint of cable giants. Others may just feel the competitive heat, adding pressure to invest in advanced digital service offerings and/or sell to larger operators seeking scale to compete and negotiate with the industry’s giants.
Again, not all bad for cable. The growing importance of the Internet and digital content require major media companies and MSOs to rethink strategies, place new bets and deploy capital in more innovative ways to grow online, Bourkoff adds. The key attribute for MSOs? The ability to make quick decisions with a flat management structure.
"We see evidence of that every day," Bourkoff says. Cable’s ability to offer a triple play almost nationwide this year, keeping a step ahead of its telephone and satellite competition, is an example, according to the analyst.
DBS: To Merge or Not to Merge?
Next year’s election result could influence acquisition activity across the media landscape. Democrats have never been fans of media consolidation. Nowhere is the political climate more pivotal than on the satellite horizon, where speculation is rampant that DirecTV and EchoStar’s Dish will take another shot at merging or be acquired by a telco.
DBS subscriber growth has slowed, largely due to cable’s surging triple-play bundle. DirecTV and EchoStar together added fewer than 1.9 million subs in 2006, down from 2.3 million net adds the previous year, Leichtman Research Group figures show. Oppenheimer analyst Thomas Eagan forecasts 1.75 million satellite adds in 2007.
Consequently, DBS is seeking partners to offer broadband data and voice services. A DirecTV-EchoStar merger wouldn’t do that directly, but would create a behemoth serving nearly 29 million subscribers, with the clout and cash flow to help fill the gaps.
But Bruce Leichtman, president and principal analyst at his namesake research firm, among others, sees Malone’s takeover of DirecTV as an end to the possibility of a DBS merger. "John Malone epitomizes the concern Washington has about the cable industry," Leichtman says.
Kaufman Brothers media analyst Todd Mitchell is more direct: "There is no way in hell that you’re going to be able to marry DirecTV and EchoStar." He adds, "That’s just not the way antitrust works. Two tenets of antitrust [law] are that you cannot go from two to one, and you cannot go from three to two."
Merger proponents argue that the competitive landscape has expanded sufficiently to allow a satellite monopoly without limiting choice for consumers. A similar case has been made by the satellite radio companies XM and Sirius. Many view that deal as the barometer of whether the political winds have changed enough in Washington to permit a DirecTV-EchoStar marriage.
With or without a merger, many see Malone and EchoStar CEO Charlie Ergen girding for a protracted battle that threatens all but the largest and most digitally advanced MSOs.
"What John Malone is very good at is running a profitable company, and he’s going to maximize revenue and maximize income," says Leichtman. "And it’s a good point in the development of DirecTV and the DBS industry to do that. He’s got the second-biggest multichannel video operator in the country, and one that is 50% bigger than TCI ever was."
"The fact of the matter is that he’s got 15 million subscribers with very attractive demographics," agrees Mitchell. "He’s got the right programming contracts. He’s got the right programming assets. I think he’s going to turn that thing into a cash-flow machine."
Ahead: Telco Tie-Up by DBS
More likely than a DBS merger, many analysts insist, is the long-rumored acquisition of one or both of the satellite operators by a telco. AT&T, which has less invested in its DSL-based video offering, is most frequently named as a likely suitor for EchoStar.
"DBS is very much a part of telcos’ TV future," predicts Mitchell, who sees Verizon’s strategy of building out its fiber-optic FiOS network as a better, albeit longer-term, battle plan than AT&T’s. "Verizon has built a very credible plant," he says. "On the other hand, DSL TV just does not work. It works in the lab. It works in a very high-density new-build situation, like Korea. It does not work in the U.S. suburbs. It does not give you enough capacity to do what you need to do.
"AT&T is a serial acquirer," Mitchell adds. "I think they’ve got the wrong strategy for telco TV. I would not discount an EchoStar acquisition down the road." Yet an AT&T acquisition of EchoStar could take time, he cautions, as AT&T is digesting BellSouth. Takeover speculation may already be built into EchoStar’s stock price, up about 20% from mid-November to mid-March.
"Would it make sense for one Bell to buy EchoStar or DirecTV?" Leichtman asks. "Not independently. It would make much more sense if they bought it in a Cingular type fashion where they share it."
Others on Wall Street see more promise in AT&T’s video platform, dubbed U-verse TV. In their view, the likelihood of an EchoStar acquisition grows slimmer as the U-verse rollout progresses. Credit Suisse’s Bryan Kraft cut his rating on EchoStar stock in March, citing that month’s U-verse launches in Dallas-Ft. Worth, Kansas City, Milwaukee and Racine, Wis., which bodes ill for an AT&T buyout that may already be priced into the EchoStar stock.
Yet the lead that cable has over AT&T and Verizon in offering the triple play of video, voice and data continues to drive speculation of DBS acquisitions, including a suggestion in a January column in The Wall Street Journal that Verizon could provide Malone’s exit from DirecTV in a tax-free swap that fits his pattern of tax-efficient transactions.
"Time to market is going to be critical. Companies that figure it out first will win," says UBS’ Bourkoff. "In the case of the communications landscape, the cable companies certainly have a product offering that is available today for consumers, while the telephone companies are building that network still, and are not yet ready to offer it on a ubiquitous basis as much as the cable operators." By the end of this year, UBS projects nearly 80% of U.S. homes will have a full, triple-play offering available from a cable company, while only 15% will have it available from a telco.
"Even the major operators should not take their eye off the ball on who is the main competitor in 2007," cautions Leichtman. "And that’s DBS."
For Cable: Consolidation
To maintain its lead over satellite and the telcos, cable needs to continue to build scale through further consolidation of MSOs, most analysts and observers agree. "We’ll continue to see potentially some small or moderate swaps," says Leichtman. "There are clearly some markets for many of the operators that go beyond just Comcast and Time Warner that fit well with other operators."
"It’s hard for me to believe that Insight is going to want to remain a separate company…that won’t be consolidated into Comcast at some point in the not-too-distant future," Pali Research analyst Richard Greenfield says. "It’s hard to imagine that at some point over the next five years [Cablevision] won’t be part of Time Warner. It’s hard to imagine that Charter — after it executes on its improvement program that it’s currently working on to get its assets up to industry peer levels — won’t look to potentially be part of a larger entity."
"Clearly, Comcast and Time Warner are already the two dominant players, and I think they’ll get bigger," agrees Reif Cohen at Merrill Lynch. "If any of the tier-one private companies decide to exit the business, ultimately they will be acquired by Comcast or Time Warner. That would include Cox or Advance/Newhouse or any other high-quality entity that may be sold, should the owners decide to sell."
The largest deals on the horizon are expected from Time Warner, once it integrates and brings its newly acquired Adelphia systems up to speed. Though it dwarfs most other MSOs, TWC is half the size of Comcast and is widely expected to go on a buying spree to close the gap.
Greenfield looks for it to take a run at Charter properties adjacent to its systems in Dallas and Los Angeles, as well as acquiring Cablevision. "I think we’re moving in a direction where, over time, there will be two large RBOCs that are doing video, voice and data, in AT&T and Verizon, and two large cable companies in Time Warner and Comcast," he says.
The key factors for consolidation: if and when the smaller MSOs decide to sell, and how large the FCC will allow individual cable operators to get.
As always, geography will be key, analysts agree. "Potentially, depending on where they’re located, [consolidation] could make MSOs more valuable," says Leichtman, citing as the most recent example Comcast’s $483 million acquisition last month of Patriot Media to fill a gap in its central New Jersey service. "If you’re not in an area where you could consolidate with a major MSO, you can put every bow or ribbon around yourself, but you won’t be attractive to Time Warner or Comcast."
But whether or not Comcast can continue to grow through acquisition may still be up to the FCC, which is finally preparing to codify the 30% market limit on cable ownership that it has enforced unofficially for the past six years. The formal FCC cap on the percentage of pay-TV subscribers a single MSO can own was thrown out in March 2001 by a federal appeals court on First Amendment grounds, but the FCC has continued to enforce the limit through its authority to approve cable mergers and acquisitions.
Comcast, with more than 24 million subscribers, is within about 3 million of the phantom FCC limit. "You have to have a willing buyer and a willing seller, and there are no sellers of cable today that I know of," Comcast CEO, Brian Roberts, told Bloomberg after Comcast’s most recent earnings release. "We’re very happy with where we are. We have no strategic need to do that [another acquisition]."
TWC, at about half of Comcast’s size, has lots of room under the cap, plus a purse full of cash and stock. "Ultimately there’s going to have to be more consolidation, if the cable industry is going to compete more effectively in the voice products and across all the services versus telephone and satellite," says UBS’ Bourkoff. "Time Warner Cable will be that consolidator. Time Warner has a lot to do to catch up."
Then There Were Two… And Two… And Two
Wall Street and cable industry analysts predict the wave of consolidation in media and communications will continue, creating new incentives for all but the largest MSOs to invest heavily or sell out.
The most likely combinations:
2006 U.S. Cable Deal activity
The largest transaction was Time Warner and Comcast’s $17.6 billion acquisition of Adelphia’s remaining assets. This transaction contributed approximately 74% of the sector’s total deal value.
Disclosed deal value ($M) 24,081
Average disclosed deal size ($M) 1,852
Total deals closed (including undisclosed deals) 25
% of disclosed deals to total sector volume 52.0%
Source: Thomson Financial as of January 26, 2007. From PricewaterhouseCoopers’ 2007 Entertainment & Media M&A Insights.