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| Opportunities & Exposures: Industry |
Merge Wrong
Douglas Shapiro
11/01/2004
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Lately, a number of Behemoth media companies have started to return capital to
shareholders, or have at least started to talk about it. Viacom, for example,
has indicated that it expects to buy back shares after its split from
Blockbuster, while Disney’s management is considering increasing its dividend
and may ask its board for authorization to repurchase shares. Comcast and
EchoStar have blown through their repurchase authorizations and gone to their
boards for more.
The media sector has been underperforming for the better
part of a decade, and the trend toward returning capital just might be the
catalyst that turns it around. These are smart moves, not the least because they
might help alleviate a widespread concern among investors that the immense media
conglomerates, many of them the offspring of high-profile M&A activity over
the past few years, are holding onto cash so that they can execute more deals
that fail to deliver on their promises.
Our research at Banc of America
Securities has led us to believe that the jig is up on huge media mergers. While
many people have railed against the social ramifications, pressing for
safeguards against media monopolies, it appears that the market may solve the
problem. Capital has fled this industry for years, and the implicit threat from
investors is that this will accelerate if media companies continue to pursue
mergers without concrete benefits.
These deals always face a serious
philosophical hurdle. On cue, the managements involved extol the potential
virtues: various economies of scale and scope, economies of stable
relationships, improved bargaining power. What they do not often mention
publicly are the inherent costs. These can include the expense of merging
disparate management teams and cultures, notably in the form of stock options or
golden parachutes for the management team of the acquired entity, and the
opportunity costs of both capital invested in the acquired unit and the selling
or buying of content and programming in the open market.
When the acquiring
company pays a premium, its management is betting not only that the benefits
outweigh the costs, but also that the benefits outweigh the costs plus the
premium. This is an accounting actuality that many media deals have not been
able to realize, particularly those mergers predicated on nebulous revenue
synergies and strategic benefits. Smaller deals that carry lesser premiums
relative to the size of the acquirer enjoy a much better chance of success,
particularly deals based on tangible cost savings or the ability to combine
underleveraged content with existing distribution infrastructure.
In our
research, we find that much of the poor performance of the sector can be
attributed to poor capital allocation, rather than slackening secular growth. We
also note that the return on invested capital for four major media conglomerates
(Comcast, Disney, Time Warner and Viacom) has been below their weighted average
costs of capital for years. They effectively have been destroying value, or at
best, deploying capital that will theoretically produce a return in the future,
but has not yet done so.
Perhaps most dramatically, we performed an analysis
showing what each of these four conglomerates would look like today, and where
the stock of each would be trading, if they had foregone their biggest deals. In
other words, what if they had just left well enough alone? For Comcast, that
means unwinding the AT&T Broadband deal; for Disney, that means undoing
Capital Cities and Fox Family; for Time Warner, that means unbundling the Turner
and, obviously, AOL deals; and for Viacom, it means eschewing Paramount,
Blockbuster, CBS, BET and Comedy Central. Based on the closing price on the date
of our report this past July, we show that Comcast shares would have been 27
percent higher, Viacom shares would have been 121 percent higher and Time Warner
shares would have been 150 percent higher than they actually were. Disney shares
would have been about even with their price at the time, arguably because the
meteoric rise in the value of ESPN has approximately offset the reduced value of
ABC and the Fox Family (now ABC Family) network.
With both Washington and
Wall Street exerting pressure on big media, the burden to prove both social and
financial benefits will weigh much heavier on future megamergers. With fewer
investment options, media companies will have little choice but to consistently
return cash. And for a black-and-blue sector, that is good news. | Douglas Shapiro is a managing director at Banc of America Securities, covering
the cable and satellite TV and entertainment sectors. |
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