Investment bank Morgan Stanley says that a deal to merge US DTH pay-TV operators DirecTV and Dish is unlikely in the near-to-medium term, largely because of regulatory concerns, but that in the longer term. industrial logic and value of a combination will grow, with regulatory obstacles potentially diminishing.
In a briefing note, the bank says that after years of relative dormancy, it believes some consolidation in cable is possible (if not likely) in 2014, but does not expect any consolidation to swing the balance of power away from content owners.
“Sparked by Liberty Media (ticker: LMCA) taking a 27% stake in Charter Communications , there has been broad media reportage about consolidation in the U.S. cable industry, focusing on the possible sale of Time Warner Cable. ( Comcast and Charter have reportedly shown interest, though neither has commented). There is ample industrial logic for consolidation, as we believe structural changes to the industry may be the only remedy to the imbalance of power in the TV ecosystem that is driving nearly double-digit programming-cost growth. However, while some deals are possible, we believe it is unlikely that Cable/Satellite operators will gain sufficient scale in 2014 to materially change the growth trajectory of programming costs,” it says.
Ascribing reasons as to why cable/satellite industry consolidation makes sense, Morgan Stanley says:
“1) Programming costs, roughly 45% to 50% of video revenue, are growing roughly 10% per year — well ahead of retail pricing. Ultimately, if this continues, it will become increasingly difficult to grow earnings before interest, taxes, depreciation and amortization (Ebitda). While not a given that consolidation would shift the leverage back to distribution, at a minimum moving to a large company’s rate card through a change of control would have short-term benefits.
2) While to date cable operators have taken share in small and medium enterprises (SME), as this business matures the opportunity will be in larger business customers that need a scaled telecom provider that can service multiple locations with a broad suite of products (including wireless services). Commercial today is growing 20% to 30% for the major players, and represents one of the rare major growth areas for the cable industry.
3) Record-low interest rates, particularly available to predictable cash-flow businesses such as the cable / satellite industry, create the ability to debt-finance horizontal acquisitions that are immediately accretive to free cash flow.
4) We may be on the brink of a new competitive reality for pay-TV: the emergence of the ‘virtual cable operator. This new nonfacilities-based competition would come from large technology companies with substantial capital, and put further pressure on distribution returns. This competition will focus on software and user-interface differentiation, an area that requires scale for product development and marketing from incumbents to respond.”
According to Morgan Stanley, a DirecTV (DTV)- Dish Network (DISH) merger is the only potential single deal, which it suggests could be transformative to the content/distribution ecosystem, but which it believes is unlikely in the near-to-medium term. “We believe regulatory issues that arose in the 2002 merger attempt remain, which combined with a relatively difficult merger environment in Washington and potential cultural issues suggest to us that a combination appears unlikely in the near term. Longer term, however, we believe the industrial logic and value of a combination increases, while regulatory obstacles potentially diminish,” it says.
“The synergy potential in a deal could be as much as about 50% of combined market cap today, we estimate. Our base case for potential after-tax cost synergies from a DirecTV-Dish merger is $2.0 billion-$2.5 billion annually by year three, about $25 billion in net present value, or a 450-500 basis-point lift to combined Ebitda margins, in part because a combined DirecTV-Dish would be the No. 1 U.S. pay-TV provider (about 34 million subscribers), potentially with enough scale to nudge bargaining power back to distribution,” it concludes.