Debunking the M&A Tidal Wave – Part II: Reviewing the Narratives

(Check out my first post analyzing the M&A landscape here.)

If you think we’re about to ride a wave of deal making, then grab your corporate strategy surfboard and let’s hit the entertainment and media waters!

Tortured analogy aside, if you saw the chart from yesterday, you know one thing…

MA PPT Chart…if you want to do M&A you should already be in the water.

If anything, the tide has been rising on M&A for years now. Deal making went from around $33 billion in 2009 (one report had it as low as $6 billion in 2008 in the depths of the Great Recession) to a frothy $200 billion in 2016. Since deal making takes time, if you waited until a judge in D.C. approved the AT&T-Time Warner merger, you’re probably too late. (And I don’t think most executives were waiting.)

Yet, the narrative after the decision was one courtroom decision will “unleash a torrent of deal-making”. Why does everyone think that?

My theory: because it is hard to look back and observe trends, as opposed to respond to events. Court cases make for exciting events. Single events get a lot of coverage. Long term trends get one or two articles a year, maybe.

So as I collected my thoughts around M&A in entertainment & media, I reviewed a lot of the articles on M&A in Hollywood. Frankly, the idea that one court case cleared the way for M&A activity isn’t the only bad narrative in this story. The idea that “disruption” is “forcing” large cable companies to merge also doesn’t hold up, to me. And that narrative even influenced the judge in the AT&T-Time Warner case.

Today, I’m going to review all the potential causes for the rise in M&A activity we see in the chart above. Then I’ll put those explanations in context of the AT&T decision. Then next week I’ll review the data to make my final prediction.

Reviewing the Traditional Narrative

Let’s start by making the case of why mergers are more frequent after the AT&T decision. From what I read, it would go something like this:

1. The entrance of tech giants (Netflix, Amazon, Apple, Google, Facebook) is disrupting traditional business models.
2. This increases the need for industry consolidation to survive.
3. But anti-trust regulators have looked skeptically at past mergers.
4. With this deal approved, companies can merge as much as they want!

I saw two major pieces of evidence marshaled for the conclusions above. First, people would use the “Disney – 21st Century Fox – Comcast” love triangle as evidence. But if anything, all the decision did was allow Comcast to bid, which it could have done anyways, and raise the price. The rate of mergers would have stayed the same. Same thing with using Shari Redstone trying to merge Viacom-CBS, which is a deal already in progress.

Second, people love to just throw out names of companies and say, “Could they merge?” If the proposed deals don’t have sources, they’re just blind speculation. Even with sources, they’re mostly talk.

Separating the Good Reasons for the Bad

Instead of crafting a narrative to suit our prediction, let’s look at all the possible reasons  for M&A activity, from the broadest reason to the most minute and ask some questions to assess their impact:

– Was this factor present in the past 10 years? 20 years? 40 years?
– Would this factor have continued regardless of the ruling?
– How important is this factor?

Industry consolidation

As I’ve mentioned before, industry has been consolidating for forty years under a lax anti-trust regime in the Justice department and in the courts. I don’t mean the media and entertainment industry, I mean all industry from healthcare to finance to retail to beverages to airlines to you name it. If every industry is consolidating (sometimes massively) then predicting future consolidation in entertainment is less bold.

I did, though, get sucked down a rabbit hole looking at consolidation in entertainment and media specifically. Consolidation is happening in every single part of entertainment from broadcast channels to cable channels to movie studios to radio stations. Even technology. So…

– Was this factor present in the past 10 years? 20 years? 40 years?
Yes, going back 40 years.
– Would this factor have continued regardless of the ruling?
Yes, the Justice Department easily blessed the Disney-21st Century Fox deal. Donald Trump’s administration and FCC chairman Ajit Pai love industry consolidation.
– How important is this factor?
Very important. As a Hollywood Reporter article said, entertainment companies have been merging since the 1940s, going through waves in the 1940s, 1980s, 1990s and the current one.

It’s a good business environment for mergers and acquisitions.

The evidence for this explanation—which specifically refutes an argument later about “tech disruption”—is that the entire M&A market is looking good right now across the economy. Indeed this is true, as this New York Times article pointed out (using Thomson Reuters data!) and Kevin Drum clarified with inflation adjusted numbers. This differs from the above explanation in that it is really about the consolidation numbers for the current economic climate.

It boils down to a few things, summarized in the New York Times piece: the tax break provides higher profits, interest rates have stayed low and the stock market is booming so firms need other ways to drive growth (and high share prices can increase capital available for M&A). So our questions:

– Was this factor present in the past 10 years? 20 years? 40 years?
It is cyclical, but has been building since the recession in 2008.
– Would this factor have continued regardless of the ruling?
Yes, that tax break isn’t going anywhere…unless a recession hits. But the ruling didn’t effect that either way.
– How important is this factor?
In my mind, nearly as big as the industry consolidation.

Technology firms are entering the media and entertainment business.

Notice, I’m not saying that tech firms are “disrupting” traditional business models. This explanation is simpler: technology firms like the FAANGs have huge amounts of cash on hand and/or huge market capitalization’s, so they are on a buying spree. This increases the likelihood of mergers not because entertainment companies need mergers to survive (they consolidate because of the above reasons), but because entertainment firms want to avoid being acquired.

– Was this factor present in the past 10 years? 20 years? 40 years?
Yes, going back 10 years.
– Would this factor have continued regardless of the ruling?
Yes, the Justice Department isn’t taking on tech giants either. Except for Jeff Bezos.
– How important is this factor?
It depends. So far, the major tech companies haven’t actually saddled themselves with a legacy content company, but built their own platforms (Netflix, Youtube and Amazon) or bought other technology companies (SnapChat, Twitch, What’sApp, Instagram). So we’ll see.

Tech companies are disrupting traditional business models.

This is the ever pervasive idea that streaming is disrupting pay and broadcast TV and music buying and radio and everything else. Oh and advertising is being disrupted too.

I look most skeptically at this explanation. The fairest way to describe this—and I’m trying to be fair—is that the new business models are cutting profit margins of traditional firms, so companies need to bulk up to maintain their profit margins. And it really is true that new entrants like Netflix offer much cheaper alternatives then traditional models, though, Netflix is less profitable in cash terms.

Like I said above, this is the explanation I value the least. Not that it doesn’t have an impact, but it has the biggest “hype to reality” ratio. Industry consolidation allows firms to increase their profit margins, which they do regardless of new entrants. Since this is happening across all industries, it seems like an explanation fitted to the data, not the true driver.

– Was this factor present in the past 10 years? 20 years? 40 years?
It is the one new factor of the last ten years.
– Would this factor have continued regardless of the ruling?
Yes. Netflix is still scary.
– How important is this factor?
It is mainly important for the mentality. It scares executives so they want to bulk up to ward it off.

Anti-trust regulators and the FCC plan to prevent further consolidation.

If you think the Trump administration had/has a plan to prevent consolidation in industry, could you please point it out to me?

Let’s be honest, the government under Trump and Republican leadership really doesn’t care about industry consolidation. Trump actually praised his friend Rupert Murdoch for making such a good deal with Bob Iger. He called it “great for job creation”. Under a Democratic President, maybe the FCC and Justice Department look skeptically at consolidation, but for all their efforts, the Obama administration only stopped three mega-mergers (Comcast/Time Warner Cable, Sprint/T-Mobile round 1, and AT&T/T-Mobile), and it only delayed the consolidation not stopped it.

So when it comes to the question, “What if the judge had ruled against AT&T?”, would that have encouraged the Justice Department to go on a spree of trust busting? I doubt it. Would they have stopped additional deals? Probably not. I think most of AT&T law suit was more about CNN then it was about the size of the deal. Consider, T-Mobile and Sprint merged before the final judgement. They weren’t worried about anti-trust. So the questions:

– Was this factor present in the past 10 years? 20 years? 40 years?
No. The government tried to stop the Comcast-NBCU merger and successfully dissuaded Comcast from the Time Warner Cable merger. But in the last 18 months? Yeah it hasn’t been a thing.
– Would this factor have continued regardless of the ruling?
Yes, it would have. Even when Obama tried to stop some mergers, over time the Justice Department was worn down. So AT&T bought DirecTV, Charter bought Time Warner Cable, and now cellular providers are merging. Again, that was all before the decision.
– How important is this factor?
Not important since it really didn’t effect the behavior of companies.

Mergers and Acquisitions are good for CEOs individually

Here’s the simplest, most human, most “economic” (or Freakonomics?) explanation for the frequency of M&A activity.

CEOs make bank off mergers and acquisitions.

In other words, if humans are self-interested, sometimes they pursue goals and outcomes that don’t align with the incentives of their company or firm. Making better products is hard. Cutting costs in painful. Merging with another company? Relatively easier and more profitable.

The trades are reporting that after a successful merger—meaning it goes through, not that it makes money—Jeff Bewkes made $50 million dollars last year, some of which was driven by Time Warner’s merger-inflated stock price. AT&T CEO Randall Stephenson can now demand a higher salary with his larger company to run. In the short term, M&A activity is rewarded by share price increases, even if the deal bombs, as happens about 50% of the time.

– Was this factor present in the past 10 years? 20 years? 40 years?
Yes.
– Would this factor have continued regardless of the ruling?
Yes, it would have. And honestly, the economy is set up to allow it to continue.
– How important is this factor?
Very. These are the self-interested decision-makers running the system. They’ll make deals to make money, and convince themselves it’s a good thing.

Playing Devil’s Advocate: Why could M&A decrease?

To summarize, the traditional narrative says M&A activity—the rate—will increase. I think it will still grow, but at the same historical rates. At worst, I’ve set a floor of “M&A activity will stay flat”, meaning it has zero growth. So at worst it will maintain its value of $140 billion in deal value per year with 16-18 mega-deals.

But could we make arguments in the opposite direction? That M&A activity will actually slow down? Sure. And if we’re building a 90% confidence interval for the future, we absolutely should give this more weight. What could stall M&A activity?

An economic slowdown

This is what stopped the last wave of consolidation. Basically, the 2008 housing crisis and Great Recession. When no one wants to lend, and share prices fall, and you don’t have profits on hand, then it freezes the market. This would slow or stop consolidation temporarily (and as I saw first hand motivate a lot of investment bankers to go to business school).

Tech continues to build not buy.

I actually don’t hate this strategy and the Bloomberg link at the top makes this case too. Amazon, Netflix and Youtube have all created businesses from scratch. Why buy a legacy company with lots of infrastructure when you can build it yourself? You potentially save a lot of money and, in some cases, it’s unclear what value traditional firms bring to the table.

But they do have some value. Disney doesn’t have its tremendous licensing and merchandising and theme parks businesses without some know how. They’ve kept these characters relevant and popular for decades. The question is: do you have to buy that company or buy those people, which is what Netflix is doing? So what tech firms collectively decide will impact the number of deals.

The number of potential partners dwindles.

This is actually the most persuasive reason for me: if everyone keeps consolidating, after a certain point there is no one left to partner with. This would easily impact the number of “mega-deals”. That said, we have a bit to go until we have complete consolidation, especially counting vertical mergers.

The market turns against conglomerates.

When I built a table to help me analyze M&A activity (collecting the data myself), I had to come up with a term for the big six movie studios. Honestly, “movie studio” sells it short and “conglomerate” makes more sense. It’s the best way to describe a company with television networks, a movie studio, TV production, gaming, theme parks and whatever else the “big 6” studios own.

Yet, in the 1980s, it meant companies like General Electric, which bought broadcast networks and made everything from industrial equipment to microwaves to Cheers. Then the market turned against conglomerates because most of the time big companies didn’t run all their different business units that well, and the market assumed that splitting conglomerates into their individual pieces would have better value.

Tech firms defy this logic. Maybe it is because the wise leadership of Jobs/Cook, Bezos, Zuckerberg, Hastings/Sarandos and Brin/Page truly does turn everything they touch to management gold. Or, they have such huge valuations being “tech” that they can enter any industry and it doesn’t matter. I’m not saying they won’t continue to be valued incredibly highly, but this state of affairs could end sooner then you think.

The political winds change

I want to put this out on Twitter, but wouldn’t the best political campaign for Democrats in the fall be to micro-target cities that have seen huge cable bill increases post-Comcast merger and post DirecTV merger? Just hit Republicans on the issue like this:

Republicans like Mitch McConnell and Donald Trump (and his lackey Ajit Pai) want to increase you cable bill to make their billionaire friends rich.

I’m not a pollster, so I don’t know. But does anything make people more angry than cable bills? Democrats use this! Either way, if a Democrat takes power in 2020, they could restart FCC scrutiny on issues related to anti-trust and merger scrutiny. It might slow the rate of mergers, but like Obama probably not stop it altogether.

We still don’t have a prediction yet

And yet we have 2,800 words on top of the words yesterday. But now that we have the explanations, on Monday, we can dig deeper into the numbers, beyond what the top line data said from Tuesday’s post.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: