Last week, AT&T (T) announced plans to buy TimeWarner (TWX). That puts the telecom into a new business. Should the merger go through, it won’t just provide the utility of a phone line or internet connection. The company will also own some of the content that goes through that connection as well.
That’s a business model followed by Comcast (CMCSA), the acquisitive firm that owns cable lines but purchased NBC/Universal off of General Electric (GE) a few years back. It’s boosted the bottom line and profit margins there in a way that the capital-intensive cable providing business alone just couldn’t do.
This is the latest twist in the consolidating media sector. Less than 10 companies account for the bulk of the media space, and now they’re merging with the companies that deliver the content.
Mergers still stand as one of the most likely reasons that stocks will trend higher. In fact, according to data from the Center for Research in Security Prices (CRSP) released last month, there are 3,267 stocks trading on U.S. exchanges. While that may sound like a lot, it’s actually a 32-year low.
Mergers and acquisitions are part of the blame. The second part is the lack of new stocks coming to market in initial public offerings (IPOs). In recent years, IPOs have been geared towards bigger, surer things.
But even then, the short-term timing hasn’t worked out well. Although shares of Facebook (FB) have soared substantially since their IPO, the initial dive that shares took from their first trading price led to a spate of lawsuits. Newer issuances have been pulled due to what’s proven to be short-term market fears.
So any way you slice it, the stock market is shrinking. But the market is also going up while it’s shrinking. Since the total market value is rising, it’s clear that today’s market approves of the increased merger activity we’re seeing.
That hasn’t always been the case — in the past the market has tended to view each merger differently, and usually with loads of skepticism. And some mega-mergers of the past have ended up being a sign of an overall market mania.
One such example was the late 1980’s junk bond-fueled merger spree culminating with the RJR-Nabisco merger. Cigarettes and crackers, together at last. What could go wrong? Besides the debt load, not a lot. But it only took the debt load to sour the markets on mega-mergers for nearly a decade.
The 1990’s brought about some tech mergers that went bust, but also brought about mergers that undid a lot of Teddy Roosevelt’s Trustbusting. Many of the big oil companies, split off from the old Standard Oil, came back together again. AT&T acquired telecom assets that were split off in 1984 after the company was ruled a monopoly. We haven’t come full circle yet on mega mergers, but we’re getting there.
We’re still a long way away from some hypothetical world shown in dystopian films where 10 publicly-traded companies own the universe. But mergers make sense in an increasingly regulated environment.
Consider the following scenario: You own a corner gas station. It’s been in your family for years. And across the street, another family has their own gas station as well.
Under U.S. law, if you both charge the same price for a gallon of gas, the government could go after both of you for collusion. If you charge more, you could be criminally charged with price gouging. If you charge less, you could be accused of “dumping” on the market to gain market share at the expense of the competing gas station.
In other words, today’s regulatory stranglehold means the best way to avoid legal issues is to simply buy up competitors. And when you get so big that you can’t buy up competition, find a complimentary business and buy that to create a “vertical merger.” That’s what Comcast has done, and what AT&T is intent on doing. Other industries have followed suit. The automakers used to just make automobiles, but they gradually bought up most suppliers in the past as well.
Just remember, mergers don’t always work out so well for shareholders. TimeWarner used to be AOLTimeWarner, which proved to be a blue-chip dotcom stock: the ultimate oxymoron. Divesting the underperforming AOL was the first step towards making the company attractive to a new suitor.
Yes, today’s proposed deal is a mega-merger in scope and opportunity. Time will tell if the merger goes through. It’s already been denounced by Donald Trump, railing against the power of the media the same way Teddy Roosevelt vowed to go after the Trusts over a century ago. Bernie Sanders came out against it too, for pretty much the same reason.
In a free market, where new entrants can easily enter the fray, it should be impossible for any single company to acquire a lot of power. But it’s clear from a regulatory standpoint that we don’t have a free market. There are a lot of hoops to jump through, and a lot of costs to do so. It’s not that smaller companies can’t compete, it’s that they can’t meaningfully contest the larger companies’ market share right now.
Today’s mega-mergers show a divergence between two distinct, yet core American values: our fundamental respect for equality of opportunity, and our love of capitalism. Given the political risks, it might be better to sit on the sidelines and watch the latest proposed mega-merger play out. Even without the political risk, there’s still valuation risk.
AT&T already has a substantial amount of debt following last year’s acquisition of DirecTV. Taking on TimeWarner’s debt means committing so much cash to bond payments that shareholders might not see rewards for some time—and that the company runs the risk of financial trouble if the economy goes from slow growth to no growth (or worse).
Bottom line, mergers are part of what’s driving the market higher. If you’re buying great companies at a good price, you might be on the receiving end of a merger offer. Time will tell if this brings the market higher, or if it’s the sign of a top.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and is managing editor of Financial Intelligence Report.
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