Merger activity

On Friday, November 22, 2013, news emerged that Comcast (CMCSA) was interested in a potential purchase of rival cable provider Time Warner Cable (TWC). The news, which came after months of speculation that Charter Communications (CHTR) was also pursuing an acquisition of Time Warner, led to a 10% spike in TWC shares to a new 52-week high of $132.92. All three companies belong to the iShares U.S. Consumer Services ETF (IYC), which seeks to track the performance of the Dow Jones U.S. Consumer Services Index. In order to profit from potential mergers and consolidation, investors must understand the forces that set off this activity.

Why rising content costs can lead to a cable TV consolidation boom

Cost pressures

Merger activity can heat up in a particular industry for various reasons, such as poor overall growth prospects for the industry, underperformance by one player within the industry, or opportunities to grow more profitability through synergies. Consolidation expectations within the cable TV industry have begun to heat up due to all three of these drivers. In the case of Time Warner Cable, several of these motivations are at play. As we saw in Part 2 of this series, underperformance has certainly been one motivating factor. However, the larger driving force may in fact be the cost pressures that the cable TV industry as a whole is facing.

Cable companies purchase the rights to air channels, or “content,” to their subscribers. Specifically, a cable company will pay content companies, such as Disney (DIS) or Viacom (VIAB), a fee based on the number of subscribers that receive a channel.

Similar to the rest of the industry, Time Warner Cable has been facing significant cost pressure, as the cost of programming content has rapidly increased. Since the beginning of 2010, the company has had to contend with a 24% rise in content costs per subscriber. Comcast has had a similar experience, with a 20% rise in just two years.

A combination of the two companies would create the country’s largest cable TV company, with a possible 34% market share. Comcast hopes the new company will have greater success in limiting the fee increases that content providers charge. With such a dominant market share and massive reach to the consumers of content, Comcast hopes that a combined entity would have greater success in negotiating content prices. This type of synergy opportunity is often a driving force behind increased consolidation activity.

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