By Gaurav S. Iyer, IFC Published : July 12, 2018

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Looking Back on the AT&T Time Warner Merger

When I first heard about AT&T Inc. (NYSE:T) acquiring Time Warner Inc. (NYSE:TWX), I thought both sides could benefit from the deal. A recent interview with AT&T CEO John Stankey has me rethinking that position—and reevaluating my AT&T stock forecast.

The interview took place in Midtown Manhattan, on the 15th floor of Time Warner’s expansive tower. It had a lot to do with turning “HBO”—Time Warner’s crown jewel—into something more like “Netflix.”

Stankey was on stage beside HBO Chief Executive Richard Plepler when he hinted at these extraordinary changes. (Source: “HBO Must Get Bigger and Broader, Says Its New Overseer,” The New York Times, July 8, 2018.)

“We need hours a day,” Mr. Stankey said, referring to the time viewers spend watching HBO programs. “It’s not hours a week, and it’s not hours a month. We need hours a day. You are competing with devices that sit in people’s hands that capture their attention every 15 minutes.”

At first, this seems like a good idea. Of course, you want people to spend more time on HBO, because that means less time spent on competing services like Netflix or “Amazon Prime Video.”

But that way lies danger.

HBO is famous for giving us shows like Game of Thrones, The Wire, and The Sopranos. It focuses on quality programming, not trash TV that you can find on every other channel. Quality is its brand, and people pay extra for that privilege.

Staying in this niche has been profitable, too.

In 2017, HBO spent $2.0 billion on content. Somehow, it managed to flip that investment into $6.0 billion in profit, whereas Netflix, Inc. (NASDAQ:NFLX) spent a whopping $6.0 billion on content and only made $558.9 million in profit. You do the math.

The fact remains that HBO is better but smaller than Netflix. That’s why it has such a loyal customer base. However, that’s also why it is now in jeopardy.

AT&T spent $85.4 billion to acquire Time Warner’s assets. In order to justify such an extravagant sticker price, it needs to squeeze every ounce of profit from Time Warner.

So, it’s no wonder Mr. Stankey dreams of transforming his boutique production house into something more like Netflix. But in trying to bring those fantasies into reality, he might face significant pushback from guys like Plepler.

A Civil War at AT&T?

Mergers can be messy, even at the best of times.

This one is no different. AT&T is a telecom giant out of Dallas, Texas with zero experience in making hit TV shows, yet it wants to dictate terms to the most critically acclaimed network of all time. It doesn’t take a rocket scientist to know that’s trouble.

We got a glimpse into the merger’s chaos when Stankey and Plepler started talking numbers.

As the head of AT&T, it is Stankey’s job to grow profits. He thinks the way to do that is by expanding HBO’s market share beyond 35% to 40%. The ceiling, he said, needs to be higher, and the way to do that is by producing more content without changing the level of quality.

Easy, right?

Plepler doesn’t think so. He explained that more funding is necessary. He said that HBO had, in the past, “played the best we could with the hand we had.” But in order to do better, it would need more capital.

Stankey seemed hesitant about committing to a budget increase, especially because he was on stage in front of dozens of journalists. After hemming and hawing a bit, though, he conceded that “there needs to be stepped-up investment.”

“Let’s give him a hand for that simple sentence!” said Plepler. “That simple sentence deserves a hand!”

Some people might consider this a sincere moment, but I think Plepler was trying to corner his boss. He was trying to make it harder for Stankey to wriggle out of his promise.

Undeterred, Stankey fired right back:

“Also, we’ve got to make money at the end of the day, right?”

“We do that,” Mr. Plepler responded.

“Yes, you do,” Mr. Stankey said. “Just not enough.”

“Oh, now, now, be careful,” Mr. Plepler said.

Yikes. That’s an awkward, brutally honest moment from two corporate warriors. And I worry that it reveals a deep crisis at the heart of the AT&T Time Warner merger, one that could destroy AT&T stock’s trajectory over the next five years.

Analyst Take

Here’s the bottom line: AT&T spent a huge amount of money on these assets. But now, it seems like they don’t understand what made those assets so valuable.

It’s not like they’re the first people to ever think: Hey, HBO does great work. Why can’t it do more of the same? There’s a simple reason—making hit television is hard!

There is no magic ingredient, no formula, that makes it easy. Thinking you can scale that process is childish. So, I’m going to suggest sitting this one out, because AT&T doesn’t appear to have the faintest idea of what it’s doing.

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