Comcast Pumps Up the Volume With Time Warner Deal

 Comcast (CMCSA) has announced plans to acquire  Time Warner Cable in an all-stock transaction at a headline price of $159 per share. Comcast will issue 2.875 shares for each TWC share outstanding. While we will adjust our fair value estimates, we continue to believe that cable stocks, including Comcast and TWC, are generally overvalued. 

Based on our stand-alone fair value estimates, which put the relative value of TWC at about 2.25 Comcast shares, we believe TWC shareholders are getting the better of this deal. However, this transaction, if approved by regulators, will further widen and stabilize the moat of the combined firm and provide cost savings that should allow Comcast to recoup the value given to TWC shareholders.

If we take our Comcast fair value estimate as a given, TWC shareholders are receiving about $130 of value, a 30% premium to our stand-alone TWC fair value estimate. The runup in Comcast shares during the past quarter has pushed the headline price on the deal to a level that TWC management can accept without drawing criticism for its handling of negotiations with Charter Communications (CHTR). Comparing this transaction with Charter's offer for TWC is difficult because of Charter's use of cash and stock. Still, we believe the Comcast transaction is very fair to TWC shareholders, as the average ratio of the two firms' share prices has hovered around 2.5 during the past couple of years.

This transaction will create a mammoth cable company. Comcast and TWC networks pass a combined 84 million homes, or about 70% of the U.S. population. In terms of fixed-line network reach, only  AT&T (T) would come close to the combined firm, with an estimated 50 million homes passed. Comcast asserts that this merger will not reduce competition in any given market, as Comcast and TWC networks don't overlap. However, the transaction is sure to draw plenty of regulatory and political scrutiny, given the massive influence Comcast will have over both television distribution and Internet access.

Comcast has said it is willing to divest itself of 3 million television customers to win approval for the transaction. At current penetration rates, that equates to about 7.5 million homes served. We doubt that level of divestitures, at less than 10% of the combined company, will change the course of debate among regulators. Comcast would still extend its reach to around two thirds of the United States from about 45% today.

Charter would clearly emerge as the most likely buyer of any divested assets. We suspect that the firms would work to improve network clustering, with Comcast probably seeking to swap some assets to consolidate its presence in Southern California. The combined firm would hold a very strong position in Los Angeles around sports content with the combination of TWC's rights to the Lakers and Dodgers and Comcast's broader NBC Universal content.

Comcast claims that it can achieve $1.5 billion in annual synergies within three years of the deal closing. That amount seems reasonable to us, given the dramatic divergence in operating performance between the two firms recently, but we don't believe Comcast needs to reach that level of savings to justify the purchase price. By our calculation, Comcast is sending about $8 billion of excess value to TWC shareholders by agreeing to the 2.875 share ratio. We believe Comcast can recoup that value by merely moving TWC's operations up to the type of margins Comcast's cable business enjoys today. 

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