Telecom Service/Media (Overweight/ Maintain ) AT&T to acquire Time Warner US-based telco AT&T’s acquisition of Time Warner will be an industry game changer Note growing investment in premium content (a growth driver for ICT ecosystem) Issue Comment Focus on CJ E&M’s efforts to improve original content and telcos’ media expansion October 27, 2016 Implications of AT&T’s acquisition of Time Warner Mirae Asset Daewoo Co., Ltd. Last weekend, AT&T announced it intends to buy Time Warner for US$85.4bn (W97tr; [Telecom Service / Media ] US$107.5/share), a 36% premium to Time Warner’s current share price. We believe the deal will be a game changer in the telecom service and media industry. Jee -hyun Moon +822 -768 -3615 1) We believe the information and communications technology (ICT) ecosystem is [email protected] entering a growth phase driven by content investment. In particular, vertical integration Nu -ri Ha of infrastructure, platforms, and content is picking up speed. +822 -768 -4130 2) Not just any content, but premium video content holds the key to success in the [email protected] evolving ICT ecosystem. 3) Telcos are taking diverse approaches to media investment. Currently, telcos are focused on the IPTV (platform) business, while content investments have generally been confined to individual projects and small firms. However, AT&T’s acquisition of media giant Time Warner would signify a much deeper penetration into the content business by a telecom operator. Premium content to be a premium factor for stocks 1) Content industry: Companies providing premium content that can generate steady mobile video traffic are likely to receive a premium. 2) Telecom service industry: The mobile video business is anticipated to lift off. For telecom carriers, monetization of video traffic can be accomplished not just through data usage but also through advertising and subscription fees. In the past, telcos tended to languish after growing on network expansion. 3) AT&T: Purchasing Time Warner will enable AT&T to diversify revenue sources, save costs, and expand into the content business, which is less vulnerable to regulations. However, the company has to overcome disputes over the high acquisition price and financing burden. 4) Time Warner: The acquisition by AT&T will allow Time Warner to provide users with easier access to mobile content, diversify markets, and improve negotiating power. On the negative side, Time Warner could lose revenue-generating opportunities from other platforms due to overlapping interests. Figure 1. AT&T’s acquisition of Time Warner from perspective of industry and each company Source: Mirae Asset Daewoo Research October 27, 2016 Telecom Service/Media ICT/media ecosystem entering content investment phase The global media ecosystem is now entering a content investment-driven growth phase, after building the necessary infrastructure and achieving scale through platforms. The same can be said for the ICT ecosystem. Amid waning consumer enthusiasm for more advanced hardware, software and content have now become the key differentiators. AT&T, having completing its communication network infrastructure, has beefed up its platform business by expanding its IPTV service (U-Verse) and acquiring satellite-TV operator DirecTV last year. With its bid for Time Warner, the carrier is now setting its sights on the content business. Netflix, a major new media player, is also focusing on content. As an over-the-top (OTT) service, the company was able to bypass infrastructure spending, and has been focused on expanding its platform globally. It is now aiming to create the world’s most extensive original and UHD content lineup. China’s Wanda Group and Korea’s CJ Group have been following similar paths (infrastructure investment platform content), with both currently focusing on content. Figure 2. Investment pattern in media ecosystem: Infrastructure → platform → content Source: Respective companies’ data, Mirae Asset Daewoo Research Not just any content is king; Focus on premium video content The familiar adage that content is king may need a bit more nuanced reworking. In the mobile age, we believe those with premium video content—content that can create a spark in traffic and build customer loyalty—will win the battle for traffic. Video is the primary driver behind global mobile data traffic. Figure 3. Global mobile video traffic trend and forecast (EB/month) (%) 40 Mobile video traffic (L) 100 Proportion of video in total mobile data traffic (R) 80 30 60 20 40 10 20 0 0 10 11 12 13 14 15 16F 17F 18F 19F 20F 21F Source: Ericsson, Bloomberg, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 2 October 27, 2016 Telecom Service/Media Telcos taking diverse approaches to media investments Telcos’ investments in media businesses are taking diverse forms. Many telcos have focused on the pay-TV market, including IPTV, as a platform in the media value chain. As for content, most telcos’ investments have been confined to individual projects and small firms. For example, Verizon, AT&T’s major competitor in the US telecom service market, has been focusing on internet platform and digital ad solutions, as evidenced by its acquisitions of AOL and Yahoo. For content, Verizon has tried to appeal to the millennial generation (born from 1981-1996) by investing in small firms, including multi-channel networks (third-party service providers that manage internet content creators’ copyrights) such as Awesomeness TV, Vice, and Millennial Media. Meanwhile, AT&T’s planned acquisition of Time Warner would signal a penetration into the traditional content market. We believe the company wants stable access to a massive reservoir of content, rather than just individual content supply contracts. Of note, we believe AT&T’s purpose in acquiring Time Warner was revealed in its statement that “the future of video is mobile and the future of mobile is video.” Among Korean telcos, KT appears similar to AT&T, given that AT&T is dominant in the fixed-line telecom market and owns a satellite broadcasting network. In the wireless telecom market, the company ranks second after Verizon. We think AT&T is betting on video content via Time Warner to achieve growth in the mobile era. Figure 4. AT&T’s approach to and status of media business investment: Infra structure → platform → acquisition of large content company Source: Mirae Asset Daewoo Research Figure 5. Verizon ’s approach to and status of media business investment: Infra structure → platform → digital ad solution s + content investments in relatively small firms Source: Verizon, media reports, Mirae Asset Daewoo Research Mirae Asset Daewoo Research 3 October 27, 2016 Telecom Service/Media Merger to be a win-win The acquisition deal’s roots can be traced in the recent business trends of AT&T and Time Warner. At AT&T, the media business has been driving up earnings. Since the acquisition of DirecTV in 2H15, the company has been enjoying growth in both revenue and operating profit. We attribute the growth to the bolstering of platform businesses (satellite TV in addition to IPTV) based on the fixed-line unit’s expansive broadband internet coverage (infrastructure). Recently, the company established infrastructure for the mobile unit’s 4G LTE services. In an effort to enhance the added value of the mobile businesses, AT&T will likely shift its attention to digital video content. Time Warner’s 2015 revenue was broken down into broadcast (56%) and film (44%). The film unit posted sizable revenue despite the highly volatile nature of the business. In 1H16, however, film revenue contracted and the broadcast unit recorded only single-digit growth in revenue. The merger with AT&T should boost the company’s digital revenue via mobile distribution of its content and also push up overseas revenue thanks to DirecTV’s coverage of Latin America. Table 1. AT&T’s major businesses’ status and income statement: Simultaneous rise in revenue and OP after acquiring satellite broadcast service provider DirecTV in 2H15 (US$mn) 2014 2015 YoY 1H15 1H16 YoY Total revenue 132,447 146,801 11% 65,591 81,055 24% 1) Telecom service/B2B solutions 70,606 71,127 1% 35,221 35,188 0% Wireless 37,223 38,640 4% 18,957 19,364 2% Fixed-line 33,383 32,487 -3% 16,264 15,824 -3% 2) Entertainment/internet 22,233 35,294 59% 11,442 25,369 122% 3) B2C telecom service 36,744 35,066 -5% 17,533 16,514 -6% 4) International telecom service/video - 4,102 - 727 3,495 381% 5) Other 2,839 1,212 -57% 668 489 -27% OP 11,827 24,785 110% 11,330 13,691 21% Note: Satellite broadcaster DirecTV has been incorporated into consolidated basis since 2H15 after it was acquired. Source: AT&T, Bloomberg, Mirae Asset Daewoo Research Table 2. Time Warner’s major businesses’ status and income statement: Film unit makes a sizable revenue contribution, but has been contracting recently; Broadcasting revenue displays low growth, with a low proportion of overseas revenue (US$mn) 2014 2015 YoY 1H15 1H16 YoY Total revenue 28,320 29,203 3% 14,475 14,260 -1% 1) Film: Warner Bros. 12,526 12,992 4% 6,497 5,767 -11% 1-1) Theater content 5,839 5,143 -12% 2,728 2,321 -15% Theater revenue 1,969 1,578 -20% 1,043 809 -22% DVD, VOD 1,913 1,717 -10% 830 542 -35% TV license fee 1,686 1,579 -6% 747 838 12% Merchandise and other 271 269 -1% 108 132 22% 1-2) TV content 5,099 5,635 11% 2,656 2,628 -1% 1-3) Game and other 1,588 2,214 39% 1,113 818 -27% 2) Broadcasting: Networks 15,794 16,211 3% 8,373 8,889 6% Subscription fee 9,841 10,054 2% 5,050 5,464 8% Advertising 4,568 4,637 2% 2,451 2,580 5% Content 1,183 1,315 11% 761 731 -4% 2-1) Turner Network 10,396 10,596 2% 5,537 5,916 7% Subscription fee 5,263 5,306 1% 2,690 2,975 11% Advertising 4,568 4,637 2% 2,451 2,580 5% Content 370 455 23% 289 251 -13% 2-2) HBO Network 5,398 5,615 4% 2,836 2,973 5% Subscription fee 4,578 4,748 4% 2,360 2,489 5% Content 813 860 6% 472 480 2% * Domestic revenue from broadcast 12,336 12,789 4% 6,568 7,130 9% subscription fee /advertising * Overseas revenue from broadcast 2,073 1,902 -8% 933 914 -2% subscription fee/advertising Total OP 5,833 6,923 19% 3,676 3,772 3% 1) Film: Warner Bros.