AT&T agreed to buy Time Warner for $85.4 billion, which is about 35% premium over the share price of the latter company. The idea is to combine the strength of quality content provided by Time Warner with a well-established distribution network set up by AT&T. Is it a good deal or not? The answer depends on whether the combined entity could create value that is greater than the sum of market values of the two entities. One plus one must be greater than two.
Professor Bharat Anand, an economics professor at Harvard Business School, thought that the merger was unwise. First of all, he thought that the premium is too high to be justified. It is more likely to breakeven many years after the merger rather earning a huge profit. Secondly, exclusivity of content could be achieved in a much cheaper way. Apple had a long contract with HBO in providing exclusive movies on ITunes. Twitter has secured an exclusive right to stream live NFL games. Amazon has just launched its Video Prime Services. None of the companies mentioned above has ever proposed a merger with another content provider. Professor Anand asked, could AT&T bundle a mobile subscription plan with Time Warner content that others could not do so without doing a merger? Obviously not he argued. That is why other competitors would be better off as they do need to pay a huge premium before contracting to exclusive contents.
So in what situation that a merger makes sense? Let’s look at other mega deals settled in October. Qualcomm, the largest manufacturer of smartphone chips in the world, is going to purchase NXP, another leading chip manufacturer for automobiles in Europe. Unlike AT&T and Time Warner, this is a horizontal merger, which means both companies are doing the same business. There is a projected revenue synergy as a spokesperson for Qualcomm said that they are looking to implement their cutting-edge technologies on automobile chips. This means that Qualcomm is cultivating a new revenue stream. Again, Baker Hughes and GE merge their oil & gas equipment department to become the world’s second largest company in this field. There is less overlapping of businesses compared with Qualcomm and NXP merger as Baqualcommker Hughes produce a different category of products. Look also Century Link and Level 3 Communications, these two companies used to provide high-speed broadband services and phone services on their own.
The difference between other deals and the AT&T merger is that the latter is a vertical merger, while the former are horizontal mergers. A vertical merger is a merger between two companies producing different goods or services for one specific service. It usually happens when two or more firms, operating at different levels within an industry’s supply chain, merge operations. A horizontal merger, on the other hand, occurs between firms that operate in the same space, as competition tends to be higher and the synergies and potential gains in market share are much greater for merging firms in such an industry.
It seems that Professor Anand’s logic is quite solid, but it does not mean that it is perfect. Look at the merger of solar city and Tesla, solar panels and batteries are complements to electric cars. I think this deal does create synergy even though this is a vertical merger. Nowadays, companies that provide a whole supply chain of products and services would stand an edge over companies that do not. Look at Apple, the combination of different devices, shared with Mac OS and a unified icloud takes mobile experience to the next level. This similar vein of reasoning could be found on another professor at Harvard Business School, Clayton M. Christensen. He said that ‘Apple’s true innovation was to make downloading digital music easy and convenient. To do that, the company built a groundbreaking business model that combined hardware, software and service.’ If you are using an Android phone, a computer running on Window OS and the DropBox cloud service, the experience would not be that seamless. So the key point of whether a merger would be successful depends on whether the combined companies could provide a different kind of service to the existing customers.
It is for this reason that AT&T and Time Warner merger might not make much sense as the customer experience would not improve significantly due to the merger. Customers are still getting the same content and the same streaming speed – an ordinary experience that a customer would get without having the merger taken place. The value of a merger depends on, first, the vision of how to take customer experience to the next level and secondly, whether the combined entity could deliver that improvement. A vertical integration is not destined to fail. One should not look at any merger purely from an economic perspective but he should also pay heed to the strength of his company and how to leverage its resources.