Did Netflix Cause the AT&T Time Warner Merger?
Chaos—absolute chaos—was the consequence of a recent court decision allowing AT&T Inc. (NYSE:T) to acquire Time Warner Inc. (NYSE:TWX).
Traders started whipsawing prices, analysts cranked out DCF models, and TV pundits declared it a “total and complete victory for AT&T.” I’m not so sure they’re right.
To me, the ruling looks more like a victory for Netflix, Inc. (NASDAQ:NFLX).
Let me explain…
Changes to the media industry didn’t start with the AT&T Time Warner merger. In reality, those shifts began 16 years ago when Netflix went public on the Nasdaq stock exchange.
The company was radical from the beginning. And its disruptive streak continues to haunt every business that’s remotely in its universe, including telecommunications firms, TV studios, advertising agencies, and production houses.
Telecom giants resent how much data Netflix consumes. Meanwhile, TV studios like Time Warner see Netflix as an existential threat to their business.
And advertisers are frustrated because Netflix is a subscription-based service, meaning it has no interest in showing ads for toothpaste or toilet paper. It cares more about satisfying actual customers.
As a result, Netflix’s dominance comes with side-effects, including:
- AT&T’s $85.0-billion acquisition of Time Warner,
- Comcast Corporation‘s (NASDAQ:CMCSA) $65.0-billion cash offer for 21st Century Fox (NASDAQ:FOX),
- Walt Disney Co‘s (NYSE:DIS) counter-offer for Fox, valued at $71.3 billion,
- And Verizon Communications Inc.‘s (NYSE:VZ) acquisitions of AOL and Yahoo! assets.
All these mergers reflect an industry in chaos. Or to be more specific, they reveal that Netflix broke the business model of television.
How Netflix Changed Television
At first, we went to Netflix for movies that had long since left theatres. Then we started going for ad-free television. Then, with the introduction of House of Cards, we started going for originally manufactured content. Netflix both made the show and distributed it.
These used to be two separate businesses. Time Warner, Fox, and Disney made television; Verizon, AT&T, and Comcast distributed it.
Netflix combined those functions. And although it didn’t make a lot of profit doing so, it continued to grow by “delighting its customers,” as Jeff Bezos would say. Now rivals feel pressured to follow suit, lest Netflix add them to its pile of vanquished foes.
Hence, the mergers.
AT&T bought Time Warner to create its own streaming bundle. Comcast wants to do the same thing with Fox. What they don’t realize, though, is that they’ve started playing by Netflix’s rules.
For example, viewers are demanding flexibility in how they view content. It’s not enough to broadcast episodes once a week. Customers want to make their own viewing schedule, and they want to be able to use a tablet or smartphone rather than a television.
Netflix started that trend. Once it had introduced that concept, everyone had to follow, making it their game to lose.
What Does This Mean for NFLX Stock?
Until these mergers took place, I worried that NFLX stock was overbought. After all, it traded at 180 times earnings, which is far more than traditional TV studios.
However, the mergers altered my calculus.
In order to complete its $85.0-billion acquisition, AT&T had to dilute its stock and increase its long-term debt. Comcast would have to borrow heavily as well.
Combined, these firms could end up with $350.0 billion worth of loans and bonds, making them the “world’s most indebted companies,” according to The Wall Street Journal. (Source: “Mergers Would Make AT&T, Comcast World’s Most Indebted Companies,” The Wall Street Journal, June 18, 2018.)
They couldn’t have picked worse timing.
You see, the Federal Reserve is on track to raise interest rates multiple times this year. My concern is that this could raise AT&T and Comcast’s interest payments, thus straining their cash flows and ultimately their balance sheets.
In other words, these acquisitions weakened Netflix’s rivals. I think this bodes well for NFLX stock, especially as it expands into international markets.
I had previously thought NFLX stock was due for a correction, but consolidation in the media industry could give it room to run. We could see a rally extend through the remainder of 2018.
However, if you’re looking for triple-digit gains, this may not be the stock for you. It’s already exhausted most of its gains in previous years.