A Huge New Sign of the Top
'The biggest mistake in corporate history'... Time Warner agrees to another massive deal... Why approval (or success) is unlikely... A huge new sign of the top...
It's considered one of the most colossal corporate blunders in history...
In early 2000, near the peak of the tech bubble, Internet-service provider AOL purchased media giant Time Warner for $164 billion. The Federal Trade Commission cleared the deal in December 2000, and AOL Time Warner was born.
But by then, the bubble was already deflating... and the value of the AOL division was plummeting...
In 2002, the U.S. Securities and Exchange Commission launched an investigation into the company's "unorthodox" advertising deals, and the U.S. Department of Justice announced a criminal probe.
AOL Time Warner eventually announced it was revising financial results after discovering it had overstated $190 million in advertising deals. The company took a goodwill write-off and announced a $99 billion loss for the year.
Shares of the company dropped more than 90% from peak to trough... and Time Warner finally dumped what remained of AOL in 2009 for a mere $2.5 billion.
In short, the deal was a disaster. Even current Time Warner CEO Jeff Bewkes – who was then head of the company's HBO division – called it "the biggest mistake in corporate history." As he famously put it in an interview years later, "You had a lot of people saying you should've combined a donkey with a rabbit and gotten a flying unicorn... Everyone bought it."
We couldn't help but think of this boondoggle over the weekend...
On Friday afternoon, reports began to circulate that telecom giant AT&T (T) was in "advanced talks" to acquire Time Warner (TWX). One day later, it was official. As the Wall Street Journal reported on Saturday night...
AT&T Inc. has reached an agreement to buy Time Warner Inc. for $85.4 billion in a deal that would transform the phone company into a media giant. The wireless carrier agreed to pay $107.50 a share, evenly split between cash and stock. The companies said they expect the deal to close by the end of 2017.
The deal represents the largest corporate buyout of 2016... the 11th-biggest takeover since 1995... and the third-biggest media acquisition of all time.
While we aren't predicting a similar disaster this time around, we note some concerning signs... both for the market in general, and for these companies' shareholders in particular.
Much like the last big Time Warner deal, media and pundits have largely praised the move.
Sure, plenty of folks have pointed out potential obstacles to the deal, including increased regulatory scrutiny, political opposition (both Donald Trump and Hillary Clinton have already spoken out against it), and objections from rival firms. But few have questioned whether the move actually makes sense in spite of these obstacles. (More on this in a moment.)
Instead, they've thrown around buzzwords like "synergies" and "disruption"... and have even predicted the deal will "reshape the media landscape." As one article in the Washington Post put it...
An AT&T-Time Warner tie-up would create one of the most powerful combinations of content and distribution America has ever seen. And the implications would be far-reaching: AT&T could offer intricate cross-promotions between different parts of its business, similar to the way it has started bundling cellular service with DirecTV, the satellite TV company it purchased last year. It could make money by licensing shows and movies to other cable companies, and also compete against them by fleshing out the offerings of its own U-verse pay-TV service.
Why approval (or success) is unlikely...
History provides plenty of evidence that deals like this rarely work out. In fact, Time Warner CEO Bewkes said as much himself. In a 2009 interview – when the company was rumored to be interested in buying NBCUniversal (which was later acquired by Comcast) – Bewkes explained that big media mergers often don't live up to expectations. As technology news site CNET.com reported at the time...
"Some deals work in media, but most have not," he added. "Over the past 10 to 15 years, there is a very low percentage of deals that have delivered what they would deliver, in terms of return on investment."
This was certainly the case for the AOL Time Warner deal. And today's increased regulatory scrutiny has only further tilted the odds against success.
Even if this deal is approved – and some industry analysts put the chances at less than 50% – the firms may have to make so many concessions that any significant advantages are wiped out. The recent Comcast/NBCUniversal deal is a great example. As Bloomberg reports...
When it bought NBCUniversal, Comcast Corp. had to accept conditions so it wouldn't be too powerful in the burgeoning web TV landscape. NBC was required to make all of its channels available to all new online TV entrants, weakening its negotiating leverage.
The entertainment division also was barred from exerting influence on the streaming service Hulu, which it partly owns. Hulu will soon unveil an online TV offering that competes with Comcast's conventional cable service.
Analysts are divided over how valuable the NBC deal has been for Comcast and whether it makes sense for AT&T to own TV networks and production studios... "None of the improvements in NBC have come from its attachment to the cable business," said Jonathan Chaplin, an analyst at New Street Research.
AT&T is also paying a hefty price tag...
According to reports, AT&T's offer values Time Warner at more than 20 times operating cash flow. This compares to the eight times operating cash flow Comcast paid for NBCUniversal.
Worse, the company plans to issue about $40 billion in new debt to finance the cash portion of the deal. This follows the tens of billions of debt AT&T took on to purchase DirecTV in a $48.5 billion deal last year.
All told, the new company would carry an enormous $175 billion in debt, according to the New York Times... making it the single largest nonbank corporate issuer. Moody's estimates AT&T currently will need to refinance nearly $10 billion of its existing debt each year. This will only increase if the deal goes through... meaning the firm's interest expenses could rise dramatically if credit markets begin to tighten as Porter has predicted.
A huge new sign of the top?
But this isn't even the worst-case scenario. Some believe the deal may turn out to be even worse than the AOL Time Warner deal... and could signify a major market top. As financial-news outlet Fortune noted this morning...
The collapse of that merger had more to do with a clash of cultures (something Time Warner CEO Jeff Bewkes was a part of) than it did any kind of inherent strategic error in the combination itself, although there's no question that AOL was wildly overvalued.
When we look at AT&T and Time Warner, it feels like a deal that is being driven by a vision of the past, not the future. It seems like a desperation move by both, an admission that they don't really know what else to do, except try to get larger and hope everything works out for the best. And AT&T is paying a huge price for an uncertain outcome.
In fact, this combination may be even more of a signal that certain markets have peaked than AOL-Time Warner, which marked the peak of the first digital bubble.
It's too soon to say if this deal will eventually be remembered for ushering in another market peak. But we wouldn't bet against it.
Clearly, Bewkes believes this deal is somehow different. But seeing folks who should know better getting carried away is concerning... It's often a sign the market is getting a little "frothy," and a top isn't far off.
Of course, regular Digest readers know there are plenty of other signs that the manipulated boom in global markets is peaking. As we noted in the October 14 Digest...
All around the world, in one form or another, the world's major economies are groaning with a debt burden they simply can no longer afford and with inflated securities prices that aren't supported by earnings or interest rates.
Sooner or later, investors will realize this game can't continue...
As default rates rise (which they have been since 2014), as corporate earnings fall (which they have been since 2015), and as global economic activity slows (which we've seen with industrial-production numbers and global trade figures), the underlying strains on the real economy are going to become harder and harder to ignore... That moment in time is approaching.
While we can't know exactly when the market will turn, we can be certain that it will. And this gives us a rare opportunity today...
The current situation – a huge bubble in stocks and bonds that is sure to pop, combined with historically low volatility – gives us a chance to buy long-term "insurance" at record-low prices. And we're launching our brand-new service – Stansberry's Big Trade – to show you exactly how to take advantage.
As we've discussed, this service will recommend buying long-dated put options against many of the world's worst corporate credits, a group we've called "The Dirty Thirty." This strategy will allow you to hedge your portfolio against a broad market decline, while setting yourself up to make 10 to 20 times your money as the inevitable bust plays out.
You can learn more now – including how you can get immediate access to all of our preliminary research BEFORE this service officially launches next month – by clicking here.
New 52-week highs (as of 10/21/16): CONE Midstream Partners (CNNX), Microsoft (MSFT), iShares MSCI Global Metals & Mining Producers Fund (PICK), and ProShares Ultra MSCI Brazil Capped Fund (UBR).
Another busy day in the mailbag: Praise for the latest from Digest contributing editor P.J. O'Rourke... a comment from a restaurant owner on the recent rash of bankruptcies... and several readers share their thoughts on Wal-Mart's move into e-commerce. Send your notes to feedback@stansberryresearch.com.
"Another classic from P.J O'Rourke! I would have written sooner, but I was busy in panic mode all weekend, stopped only by the distraction of NFL Sunday Ticket and the Red Zone channel. Hopefully we will all have the energy to repair the damage done to our futures by Nov 8. I'm worried." – Paid-up subscriber Eric W.
"Guys, looking forward to reading Casey's Speculator and have put it on my Wish List. Loved PJs column... great humor that is to the point, as always. One minor correction, though: When the government (Roosevelt) finally paid the people for their confiscated gold, they only paid $22 per ounce, even though the market value at the time of confiscation and at the time of the payback was $35." – Paid-up subscriber Joe G.
"As a restaurant owner I can tell you the simple reason they are closing. Minimum wage in states like where I am in California. We have to pay $10 per hour and it's on the way to $15. Labor makes up 45% of our expenses vs 25% 10 years ago. We can raise prices but only so far. Further because we have several locations we now have to offer benefits and paid sick leave. They also keep raising fees and sales taxes. It's only going to get a lot tougher..." – Paid-up subscriber C.M.
"Regarding your comments concerning Walmart's gamble on e-commerce, I had a recent experience that might offer them hope of being successful. We have a medium-sized Walmart about three miles from our house. I recently searched their website for a personal care product ($8 value) and found that it was not available at our local store, but that I could order it online for pickup the next day. I placed the order and did the pickup the following day when I was running other errands. The advantages to me were 1) avoidance of shipping cost ($5+ on an $8 order) and 2) product in hand the next day. A surprise benefit was that I could pay for the item at the Pickup counter instead of having to wait in Walmart's usual tedious checkout lines for in-store goods. Walmart has an advantage over Amazon in that they have brick-and-mortar facilities in hundreds of communities around the country where online customers can pick up orders and avoid shipping costs. Walmart is behind the curve in e-commerce, but I would not underestimate their ability to compete with Amazon in that space." – Paid-up subscriber Jeff N.
"I bought some items from Walmart by email because their price was cheaper, included shipping and if there was a problem with what I bought, I could return it to any Walmart store. This return policy may be their advantage over Amazon and others. P.S. delivery was quick." – Paid-up subscriber Charles M.
"One of the reasons that buyers might choose on-line purchases from Walmart vs. Amazon is that (currently) most online orders sent to a Walmart store for pickup are sent for free. More importantly, if you don't like the item, you can return it in the store without having to reimburse the outbound shipping nor bear the return shipping. I think if Walmart continues this policy, they will be able to compete with Amazon in eCommerce as well as draw some incremental traffic to the stores." – Paid-up subscriber Ira Cotton
Regards,
Justin Brill
Baltimore, Maryland
October 24, 2016