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Charter Deal: Game Changer

Five Ways the Time Warner Cable Buy Will Shape the Industry 6/01/2015 8:00 AM Eastern
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Charter’s acquisition of Time Warner Cable and Bright House Networks will reshape the industry in several ways.

What next? The question lingers in the minds of many after Charter Communications finally hammered out an agreement to acquire Time Warner Cable in a transaction valued at $78.7 billion, while simultaneously inking a deal to bring 2 million-subscriber Bright House Networks into the fold for a cool $10.4 billion.

 

The deals would give the combined companies 17.3 million video customers, solidly placing it into the second spot among U.S. cable companies and a making it a close third among multichannel video service providers behind the combined DirecTV-AT&T (26 million if its merger is approved by regulators) and top cable MSO Comcast (22.4 million).

 

The transaction is a pricey one — at 9.1 times 2015 cash flow, the TWC deal has one of the richest multiples in years — but is expected to reap benefits for both Stamford, Conn.-based Charter and TWC shareholders.

 

According to some analysts, the union brings about $150 million in annual programming costs savings for Charter as a result of the added scale (Charter currently has about 4.3 million video customers). And Charter has said that it will expand broadband services throughout its footprint — particularly in rural areas — as well as expand its WiFi presence, which should earn points with regulators.

 

The deal also returns to the U.S. cable scene one of its most legendary figures, Liberty Media chairman John Malone, whose vision that added scale could help turn the tide back towards distribution companies from programmers fueled the consolidation wave in the first place. Malone’s $4 billion investment in Charter in 2012 helped drive the former secondary-market cable operator into the big time.

 

Charter’s initial pursuit of Time Warner Cable in 2013 was thwarted by Comcast, whose $67 billion merger offer was accepted by TWC in February 2014. But resistance from Federal Communications Commission chairman Tom Wheeler and other regulators gave Charter another chance.

 

Charter still believes it can run operations better, by completing the all-digital upgrade started as part of TWC’s three-year business plan and simply offering better products and better customer service. Charter CEO Tom Rutledge calls it taking transactions out of the business — basically extending the life of the customer and reducing churn — and he is basing a big chunk of the expected $800 million in cost synergies expected from the deal on that exact premise.

 

The deal is a bonafide game changer for the cable industry, one that highlights the importance of broadband and video scale and could help shift the dominance enjoyed by programmers for years back to distributors.

 

Many analysts are split on the deal: Some believe Charter paid too much for TWC and will have difficulty in achieving the goals it has set for itself; others believe those goals are too conservative. But there are several undeniable truths that will result from one of the largest deals ever in the cable television industry. Here are five of them.

 

1 It will drive the deal market to new heights. Already one domino has fallen, albeit one week before the Charter deal was announced — midsized operator Suddenlink Communications was sold to European telecom giant Altice for $9.1 billion. Altice, according to reports, was actively involved in the TWC bidding, but dropped out when the bidding got too rich, but not before helping to drive up that price. Still, the telecom giant is hot for U.S. cable and has met with deal brokers and bankers to map out its strategy.

 

Whether that will include the usual suspects like Mediacom Communications and Cox Communications remains to be seen. At last month’s INTX in Chicago, Cablevision Systems CEO James Dolan let his desire to be acquired or partnered with be known and reports have said that Altice hasn’t ruled out a relationship with the Cablevision. And there are about 10 family-owned cable companies in the U.S. valued at $500 million or more each, so the deal pool is chocked with potential. (Cox Communications said, in a statement attributed to president Pat Esser: “We’ve been clear that Cox is not for sale. We’ll continue to aggressively invest and innovate within our product portfolio and explore other potential growth opportunities that align with our business objectives.”)

 

Adding to the urgency to sell could be the potential that programmers will make up lost affiliate fees from the stronger Charter — analysts predicted the deal will cost programmers an annual $150 million in license fees currently generated from the merging companies — by raising prices for smaller operators. That and the high multiples being paid for TWC and Suddenlink (estimated at 9.1 times and about 10 times cash flow) could be factors that lead smaller cable companies to the negotiating table. (As an aside, John Malone sold his Tele-Communications Inc. to AT&T in 1998 for an estimated 13 times cash flow).

 

In addition to Altice, other private-equity firms such as GTCR (which bought New- Wave Communications in 2013), telco TDS (which purchased Bend Broadband in 2014) and Canadian cable company Cogeco (which purchased Atlantic Broadband in 2012) could all re-enter the fray.

 

“Cable operators inevitably have to sell,” Pivotal Research Group CEO and media & communications senior analyst Jeff Wlodarczak said. “Scale matters, and the bigger Charter and Altice get, the smaller the NCTC [National Cable Television Cooperative] gets and the less leverage the remaining players have, forcing more consolidation.”

 

But many observers don’t expect a flood of deals until after the Charter-TWC deal closes, expected by the end of the year. Then, all bets are off.

 

“There is going to be a lot of activity,” said one member of the financial community who asked not to be named. “This is the time in a market when people start making these decisions; to get out now while the price is still good.”

 

2 Content is no longer king … The continued consolidation of the cable business could finally turn the tide of dominance from content companies, which have imposed sharp increases in affiliate fees as the popularity of their networks grew, to distributors, who continue to control the broadband pipe.

 

With nearly 66 million television homes locked up with three providers (DirecTV-AT&T, Comcast and Charter) and more than 41.8 million broadband customers controlled by the top two cable companies (Comcast and Charter), distributors would have their best chance in years to flex those muscles with programmers and refuse to carry networks, or at least pare down the bundle of networks they buy.

 

While that has already been done with with Cable One and Suddenlink’s decision to drop Viacom’s channels several months ago, the real test may be coming in the next few months when Discovery Communications’ carriage deal with Comcast and Dish Network’s Viacom deal expires.

 

Discovery’s feet will be first to the fire — its current Comcast deal ends on June 30 — and some believe that unencumbered by intense regulatory scrutiny, Comcast may finally be emboldened to drop the company’s networks or push for major concessions. Dish Network’s current Viacom deal, which is estimated to expire at the end of the year, could be a major milestone — a drop could be the final blow for the home of MTV; a deal could bolster it in the eyes of other distributors.

 

Viacom’s recent deal with midsized MSO Mediacom Communications resulted in a 3% lift in Viacom’s stock price, so investors are watching. Dish chairman and CEO Charlie Ergen has thrown out mixed signals concerning Viacom, on one hand praising the networks for their more than 20-year relationship with Dish, while noting that the media giant’s negotiating leverage has waned in the wake of falling ratings and a talent exodus at key shows.

 

Wlodarczak wasn’t ready to call for content’s demise, but warned that exorbitant programming price increases could lead to “an acceleration away from pay TV to entertainment alternatives and they will go from analog dollars to digital pennies.”

 

3 … but broadband is. The combined Charter-TWC-Bright House will control about 19.4 million broadband customers and, perhaps more importantly to federal regulators, about 30% of homes with access to Internet service speeds of 25 Megabits per second or greater. That is still below the 34.6% of 25 Mbps homes controlled by Comcast, but it is a substantial rise and is expected to get even bigger. TWC had targeted adding 500,000 broadband subscribers from digital subscriber line services over three years and Charter’s markets are rife with DSL customers.

 

Even with the added bulk of DirecTVAT&T, which will have about 26 million video customers if that deal is approved, Charter will far surpass it on the broadband front and has the two-way infrastructure that DirecTV lacks.

 

“That’s a huge disadvantage,” MoffettNathanson principal and senior analyst Craig Moffett said. Over time, the additional scale could allow Charter and Comcast to compete more aggressively with telcos, and to launch major initiatives on the large-business and wireless markets.

 

Broadband pricing could be a major issue going forward. While some cable operators are experimenting with usage-based pricing, the new Charter could implement its own take on the concept. Rutledge has said in the past that Charter does not impose usage caps nor does it rely on usage-based pricing and will continue that practice. But that view also could change after the regulatory process ends.

 

4 Cable operators cooperate more, pushing TV Everywhere service. Malone has always been a big proponent of cooperation between cable operators, believing that the industry dropped the ball early on by not creating a Netflix-like streaming service well before Netflix did. He has also been critical of the way the industry has dragged its feet on the rollout of TV Everywhere service, which while improving is nowhere near its original vision of content anytime, anywhere. Charter CEO Rutledge has said a national service is a “possibility” but left the speculation at that.

 

Malone has complained in the past that companies like Netflix have to share in the cost of the bandwidth they are using. Netflix did sign a peering agreement with Comcast in 2014, but CEO Reed Hastings immediately criticized the practice of charging more for better access, calling it an “arbitrary tax” for content providers.

 

A perceived lack of leadership also has nagged at Malone for years. In October 2013 at Liberty Media’ s Investor Day, he told Multichannel News that the previously announced desire by Comcast chairman and CEO Brian Roberts to license its X1 operating system to other operators was a good start toward filling that void.

 

“It would be magnanimous of Brian to be that kind of a leader and offer his technology to everybody,” Malone said at the time, conceding that some operators may be reluctant to entrust something as important as their technology platform to an outside company, but adding that the industry needs to get past that kind of thinking.

 

“If the industry is in a situation where nobody trusts anybody, then there is no leadership and nothing is going to happen,” Malone said at the time. Now Rutledge and Malone may be the ones to take the mantle.

 

5 Programmers will be forced to fight scale with scale. Stronger distribution companies will beget stronger content providers, according to some analysts. And it wouldn’t be unprecedented.

 

Rupert Murdoch’s 21st Century Fox made an unsolicited $80 billion bid for Time Warner Inc., which was rejected back in June 2014, just months after the Comcast-TWC deal was first announced. While that consolidation wave never came to be, it could be reborn if content providers suspect that burgeoning scale threatens to encroach on their core business.

 

While Time Warner has proven it can survive on its own — its stock price is now well above Fox’s June offering price — other smaller players may see an advantage in joining forces. Companies like Discovery Communications, Scripps Networks, AMC Networks and Crown Media Family Networks have all been singled out as consolidation candidates in the past several months. And despite denials from both sides, a reuniting of Viacom and CBS also could be a way to counteract distribution scale.

 

As one cable executive who asked not to be named said, any content provider who doesn’t have sports rights is probably seriously considering what the future will hold, and whether it may be time to consider joining forces with a larger company.

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