AT&T Announces Intent to Acquire Time Warner IDC's Quick Take M&A Announcement Highlights IDC's Point of View

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AT&T Announces Intent to Acquire Time Warner October 24, 2016 By: Carrie MacGillivray, Greg Ireland, Matt Davis, Karsten Weide, John Jackson

IDC's Quick Take On Saturday, October 22, 2016, AT&T announced its intent to purchase Time Warner for $85.4 billion. Time Warner holds several appealing content assets including HBO, CNN, TNT and TBS, in addition to its Warner Brothers Entertainment division. The news builds upon AT&T's 2015 acquisition of DirecTV and its plans to launch DirecTV Now in November 2016 as an OTT offer to its wireless and wireline customers. M&A Announcement Highlights The AT&T acquisition of Time Warner adds several content and entertainment assets to AT&Ts portfolio of wireless and fixed services. The 2015 acquisition of DirecTV provided AT&T with a strong content delivery vehicle. The current deal will provide AT&T with Warner Brothers Entertainment (television, feature film, home video & video game productions and distribution); the HBO family (including HBO Now and HBO Go); and Turner (including CNN, TBS, TNT and the rights to MLB, NBA and March Madness broadcasts) as well as investment in OTT and digital media such as Hulu, Bleacher Report, Fandango and CNN.com. At the end of the day, AT&T is purchasing a rich selection of content production and distribution. For AT&T, Time Warner will bring further diversification to the carrier's revenue picture. In the 1H16, AT&T posted revenues of approximately $81.1B and with Time Warner posted revenues of $14.3B. Within a combined entity, Time Warner would represent approximately 15% of revenue contribution. In addition to content, there is also some diversification outside the United States including Latin America where Time Warner owns a majority stake in HBO Latin America – an OTT service available in 24 countries. The deal also has the potential to make AT&T one of the most leveraged companies on the planet. Taking into account Time Warner's debt, the deal is actually worth $108.7B. With debt already at approximately $119B, there's a strong likelihood that the stock and cash Time Warner deal would add considerable debt onto the carrier's existing debt load. The deal was approved, unanimously, by the boards of both companies but still requires approvals from Time Warner shareholders. AT&T announced the deal is expected to close by the end of 2017. The success of the acquisition also depends upon approvals from the U.S. Department of Justice and the Federal Communications Commission. IDC's Point of View The acquisition of Time Warner by AT&T has many implications across the video content production and distribution value chain. IDC's telecom and media team has prepared a coordinated perspective on this landmark acquisition. Moving Beyond "The Pipe"

IDC #lcUS41879116 When AT&T purchased DirecTV in 2015 (deal valued at $49B), it was clear that the acquisition was not about getting into the content provider business (versus distribution) but rather a way to acquire scale quickly to use as pricing leverage with content providers. Based on the recent developments, its apparent the carrier has decided that it needs positions all along the content creation, distribution and delivery value chain. This is proven by the fact that several of the major telecom players – Comcast, Verizon and now AT&T – have evaluated the future of playing strictly in the distribution piece of the entertainment business and have concluded that diversification into content is a prudent path. These companies appear to see a lot of potential for content ownership in the long run. And with content gaining more and more value as broadband networks – both fixed and wireless - become faster and enable new paths for video distribution via OTT, it makes perfect sense to get ahead of this trend and try to control as much content as possible. The challenge will be combining the value proposition for consumers across the services delivery (i.e. broadband) and content platforms. In its press release, AT&T stated that "the future of video is mobile and the future of mobile is video". While video content is delivered across fixed and wireless networks, its apparent that AT&T sees the mobile network playing a pivotal role in AT&T's "content" delivery strategy. As a means to compete in an extremely competitive environment, the carrier sees content as a means to differentiate and drive customer value, and in turn, loyalty. For consumers, the Comcast/NBC Universal deal of 2011 doesn't appear to have helped them much at all (i.e. Comcast hasn't lowered its prices). Yet it provides a worthy precedent that AT&T will point to during the regulator review. Unlike its failed bid for T-Mobile in 2011, AT&T is not acquiring a direct competitor but augmenting its content distribution capabilities with content creation where, arguably, no one market is being materially concentrated. As well, the likelihood that Time Warner's vast portfolio of content will be subject to distribution through AT&T’s wireless and possibly other networks at “sponsored” rates – or “free” with your monthly data plan – should have regulators’ full attention. Whether this happens doesn’t change the matter that all carriers are engaged in this distribution practice today, but if it happens it would likely see AT&T with a dramatic advantage in terms of its content library. IDC expects this matter to receive legislative attention – with regards to Net Neutrality in particular - at the U.S. federal level in 2017. Video Services Transformation From a video services perspective there are a number of ways to look at this deal. On the one hand, the acquisition of a large media company can be viewed simply as part of ongoing diversification. It’s been said of the Comcast acquisition of NBC Universal that one driver of that deal was for Comcast to have a stake in both sides of the content business – distribution and ownership/production. When one considers the likely regulatory response – a requirement that TW content, like NBCU content, not be withheld from other distributors both in traditional pay TV and OTT environments – one can still see value in a large media company contributing revenue and profit to a parent company. But, of course, this passive ownership of a big media company is not where the action is. Rather, the implications for AT&T with respect to its own OTT aspirations ought to be at the forefront of this analysis. Conversely, the acquisition of a large media company can be viewed as a strategic move to buttress an emerging OTT initiative that threatens to disrupt the U.S. video services market. The video assets

©2016 IDC #lcUS41879116 2 involved are extensive: HBO, CNN, TNT, TBS, Cartoon Network, Warner Bros. Entertainment and more (including part ownership of leading OTT video provider Hulu). The names here are just the tip of the iceberg as the content held by these entities include Game of Thrones (HBO) and NBA and NCAA March Madness basketball and MLB baseball (Turner). Hot original TV programming and exclusive sports content are key differentiators in the video market and AT&T, through this acquisition, will hold rights to an array of premiere content. When considering how regulators might view this deal, it’s important to think about the changes that have taken place in the video ecosystem in the last 5-10 years. In years gone by, content distribution through traditional pay TV providers (cable, satellite and telco TV providers) was the norm. In this framework, content owners sought to maximize distribution through as many pay TV providers as possible. To a large degree we have seen that paradigm continue even post-Comcast/NBCU as leading NBC programming networks are still available across the landscape of pay TV providers. But in recent years, the emergence and maturation of OTT has changed much of the focus from maximizing content distribution to maximizing service differentiation. In this framework, exclusive content is at the forefront of service differentiation as Netflix, Amazon and Hulu seek to drive subscriber growth and viewership through original content. In this regard, these OTT services are more akin to a premium channel such as HBO or Showtime than a traditional pay TV service. But as the lines between OTT and traditional pay TV continue to blur, so too will the distribution paradigm continue to shift. As AT&T prepares to launch its OTT pay TV service DirecTV Now, this deal must be viewed in the context of how the acquired content might be leveraged in the new framework. Regulators will surely seek to require AT&T to maintain distribution relationships with other distributors (both pay TV and OTT) at least for some time duration. But is the objective here not maximizing distribution but rather maximizing differentiation and might there be efforts to model DirecTV Now more of the content differentiation strategies of Netflix and Amazon than on those of Comcast and Charter (or even AT&T's own declining U-verse TV)? Could March Madness streaming, for example, be accessible only to AT&T customers? For its part, AT&T has already noted that restricting distribution “doesn’t make a lot of sense” but, while that is true in the convention pay TV sense, we are on the cusp of increasingly unconventional pay TV services (such as DirecTV Now). Advertising Angle All carriers today are scrambling to figure out how to apply their rich data graphs. AT&T has been clear that it sees its strength in being able to bring highly targeted ads to premium content whatever the bundle or whether that content is distributed in a managed or unmanaged way – this as opposed to competing with Google or Facebook’s “graphs”. Notionally AT&T is now in a position to more deeply integrate ad targeting across TW’s library. With the acquisition of Time Warner comes prime TV publishers such as CNN, TBS, TNT and Cartoon Network, all of which bring a lot of TV advertising sales in their own right. These, in theory, AT&T could pool and then turbocharge by applying its advanced TV advertising technology. But more importantly, these companies also provide a lot of digital video advertising inventory. This is important since video is the future of advertising, yet AT&T so far has little video inventory in its own right. Competitive Landscape

©2016 IDC #lcUS41879116 3 Comparing AT&T and Verizon after this announcement places the two companies in two distinct categories. Assuming this deal passes the regulatory hurdles, AT&T will have acquired two major media and content companies in the past year and a half. In the same timeframe, Verizon has acquired internet relics AOL and Yahoo, though the status of the latter is pending. The disparity between the moves is telling of the competitive position and strategic direction of both companies. AT&T is going all- in on content and media distribution, while Verizon appears to be more focused on ad-targeting and a small scale content distribution offer. Bottom Line Ironically, the comments in 2005 by then AT&T CEO, Ed Whitacre, may have foreshadowed some of the thinking behind the strategy leading to this deal. He is quoted as saying, "They don’t have any fiber out there. They don’t have any wires. They don’t have anything. They use my lines for free and that’s bull. For a Google or a Yahoo! or a Vonage or anybody to expect to use these pipes for free is nuts!" With the FCCs reclassification of broadband as a telecom service, the FCC has strongly signaled that potential opportunities to experiment with new ways to monetize the broadband network through metering, prioritization, or capping schemes will be under significant scrutiny. Therefore, if, like AT&T, you are a broadband provider that can afford the bill, the thinking may be - if you can’t beat them, own them. Additional contributions by Brian Haven, Courtney Munroe and Mark Winther.

Subscriptions Covered: Consumer IT Watch, Mobile Consumer Application Platforms, Mobile: Global Overview, Multiscreen Video, United States Consumer Multiplay and Broadband Services, United States Mobile Consumer Services, Worldwide Digital Advertising Market Model, Worldwide New Media Market Model

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