AT&T is Doing What???

We have written about cord cutting in the past, and the continued defensive theme is that cable/FIOS and media are converging with cable buying media. AT&T announced a deal to acquire Time Warner (TWX) for $107.50 per share. The next question to ask is why is the stock trading for ~$87.50 today. Can I make $20/share by buying TWX? Let’s evaluate that more closely by using Sentieo’s Doc Search for the merger agreement. See below for the results.


That was a quick doc search result on Sentieo to find the terms of the deal:

Based on AT&T’s stock price, the value of the deal changes based on the Exchange Ratio. If AT&T’s stock is below $41.35 the exchange ratio will be 1.3 T shares per TWX shares. If their stock is less than $37.41 then the exchange ratio will become 1.437. Everything in between is pro-rata between the spread.

HOW DO YOU MAKE MONEY ON THIS?

There are two ways to make money on this trade: 1) if T stock stays stable an investor can make this arb spread of 16-22% over the next 12-18 months which will require significant regulatory review. This would take ~35% drop in the stock to break even. 2) You can hedge the stock portion of this spread by buying 1 share of TWX and shorting ~1.36 shares (the midpoint of the arb spread). In scenario 2, when you short AT&T’s stock you will also be paying the dividends out as well so that will lower the returns based on the time frame of the deal.

Election Fears

Sentieo has been writing blog posts about the impact of the election on retailers and restaurants. In the case of a blue wave in the election (i.e. a Democratic landslide with the President, House and Senate), this deal may be perceived to more heavily scrutinized. There are good precedents in this transaction under a Democratic administration, such as Comcast acquiring NBC, which will set good solid guidelines for the review. The Comcast/NBC transaction took 18 months to close and turned out to be a homerun for Comcast as their stock more than doubled in the following 18 months. This deal is transformative for AT&T as they are no longer the dumb pipe for wireless and broadband; they will have real content and may offer discounts on HBO in their coverage regions. HBO has a long way to go as they emerge as a Netflix competitor, but AT&T has many creative options on how they can shape it.

Conclusion

With Clinton as the favorite in the election and a potential landslide Democratic takeover of Congress, some of the deal scrutiny may be priced into the merger arb spread. However, in the event of a blue wave, the arb spread may widen given the recent precedent of the Comcast/Time Warner Cable merger rejection from the DOJ. The right entry point may be after the election, as this deal has minimal regulatory issues but may be highly publicized. AT&T is basically the modern day utility company looking for growth – they have a stable business and pay out a good portion of their earnings for dividends but are very focused on what could be next…

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