By Roger Conrad
AT&T /zigman2/quotes/203165245/composite T -1.79% and Verizon Communications /zigman2/quotes/204980236/composite VZ -0.89% have emerged as two of the biggest players in the U.S. telecom market, a status achieved through hundreds of billions of dollars' worth of acquisitions and capital expenditures over the past two decades. Competitors such as Sprint Corp /zigman2/quotes/208685669/composite S +1.47% and T-Mobile US /zigman2/quotes/204659678/composite TMUS +3.94% haven't been able to keep pace.
To varying degrees, the two juggernauts appear to be following Comcast Corp's /zigman2/quotes/209472081/composite CMCSA -0.11% playbook of marrying its broadband network to high-profile content via the acquisitions of Hulu, NBCUniversal, Dreamworks Animation, and other properties.
These investments have helped Comcast to deliver double-digit earnings and dividend growth consistently, despite customer attrition in its core cable-television business.
The business of AT&T
AT&T posted solid third-quarter results, headlined by a 4.6% uptick in revenue from year-ago levels and an 11.2% increase in net income. The telecom giant also hiked its quarterly dividend by 2.1% and generated enough free cash flow to cover this payout and leave $4 billion to spare.
The churn rate in AT&T's wireless business tumbled by 11 basis points to 1.05%, while the number of devices connected to its wireless network increased by 2.3 million from year-ago levels. The company also added wireline internet and DirecTV subscribers.
However, AT&T's third-quarter results suggest that the growth rates at its core wireless and television businesses have stalled in the face of intensifying competition. Management calls for the company to add fewer net video customers this year than in 2015. AT&T also lost broadband business customers in the third quarter, and phone-only postpaid (contract) sales dropped 1.9% sequentially.
This slowdown, though far from disastrous, may have prompted AT&T to bulk up its content offerings by agreeing to acquire Time Warner — the parent company of HBO, CNN and the Warner Brothers film studio — for $85 billion in cash and stock.
What buying Time Warner means
This prospective tie up between two household names has generated a flurry of commentary in the financial and mainstream media. Here are some of our key takeaways for investors.
AT&T aims to achieve $1 billion in annual synergies from its acquisition of Time Warner within three years and expects the deal to be accretive to earnings per share in the first year. Whether the company will hit these targets remains to be seen, but Comcast's integration of NBCUniversal provides a template for success. AT&T's 4G wireless network also gives the firm an advantage over Comcast, as consumers increasingly view video content on mobile devices.
The sharp selloff in AT&T's share price after news of the deal broke reduces the potential downside risk if the transaction falls through.
The terms of the deal minimize the risk of dilution to AT&T's shareholders and don't overburden the company's balance sheet. Investors in Time Warner will receive $53.75 in cash and 1.3 to 1.437 AT&T shares for each share in the media company. If Time Warner walks away from the deal, AT&T will receive $1.7 billion in cash.
The Federal Communications Commission won't play a major role in the approval process for this transaction because no network assets will change hands. However, the U.S. Department of Justice likely will scrutinize the deal closely. Several high-profile politicians have come out against the proposed acquisition, suggesting that Congress could seek to get involved.
AT&T and Time Warner expect the deal to close before the end of next year, implying a contentious approval process that ultimately will play out in their favor. This bolt-on transaction should ultimately win approval from the Department of Justice, though some concessions may be required.
Skepticism about the deal's merit runs rampant. John Legere, CEO of T-Mobile US, derided the transaction as a sign of AT&T's weakness and an indication of his own company's success in taking market share from the larger company.
The combined company will also carry a heavier debt load, which prompted the three major credit-rating agencies to put AT&T on watch for a potential downgrade.
After the pullback, AT&T's stock looks like a good buy for income-seeking investors, though the high-profile nature of this deal could result in additional volatility.
Verizon Communications hasn't moved as aggressively as AT&T into the content business, focusing instead on the Internet of Things and machine-to-machine communications .
During Verizon Communications' third-quarter earnings call, management reiterated that the company will push forward with its $4.3 billion acquisition of Yahoo! , despite a massive data breach at the internet-media company. The two sides expect the deal to close by year-end.
Verizon Communications can afford to take a measured approach to acquisitions because its core wireless operations haven't felt as much of a pinch from intensifying competition.
If the company decides to pursue a larger deal to expand its content capabilities, Walt Disney /zigman2/quotes/203410047/composite DIS -1.65% or Viacom /zigman2/quotes/206819775/composite VIA -1.32% could be options. Alternatively, the company could continue to focus on smaller acquisitions.
Disclosure: Conrad owns VZ, T and TWX.