THE ECONOMICS OF MEDIA MERGERS AND ACQUISITIONS

Due to First Amendment considerations, electromagnetic spectrum management, and common carrier regulation, communications companies have historically held a special place in public policy and have subse- quently been subject to a unique degree of regulation. These policies have been critical in shaping the structure of the industry. However, within the sets of policies that define the structure of the marketplace, communication companies are not unique financial organizations. They are well suited for examination based on established theories and methodologies of economics and finance.

During the past decade an unprecedented combination of media companies and acquisitions by large media have resulted in six companies dominating the U.S. mass media and fewer than 10 dominating the global media market (Bagdikian, 2000). This merger and acquisition activity (M&A) has been driven by financial and strategic considerations. Media companies, similar to other enterprises are run by a management team under the oversight of a board of directors with the goal of maximizing the long run value 1 of the shareholder’s common stock. M&A have become a key tool in trying to achieve this objective.

The technical distinction between a merger and acquisition can be com- plex. In the most basic sense in a merger transaction, two companies are combined into one company that assumes all assets and liabilities of both companies. In an acquisition, one company buys the common stock of an- other, thereby assuming ownership. In some cases, a company purchases all or a portion of a second company’s operating assets instead of the common stock in a transaction referred to as an asset acquisition.

In the United States, the volume of merger and acquisition activity has varied greatly although the activity can be described as having occurred in waves. Macroeconomic factors have an obvious effect on M&A activity. In- terest rates, inflation and their volatility are the most important variables in valuation models. They affect the return on capital as well as the ability to secure financing. Business cycle factors must also be considered in forecasts and are critical to valuation and deal structure (Reed & LaJoux, 1998).

The fundamental reason to undertake a merger or acquisition is one of economic gain: that two firms combined are worth more than the sum of each individual firm, or the classic argument of synergy, 1 + 1 > 2. In finan-

1 There is a significant literature debating whether long-term profit maximization is indeed the goal of corporations (see generally, Scherer & Ross, 1990).

3. STRUCTURE AND CHANGE

cial terms, the net present value of the gain associated with the combination must exceed the cost of the transaction to the acquiring company.

Mergers and acquisitions are often categorized as horizontal, vertical, or conglomerate. In a horizontal merger a company acquires a second company in the same or similar business. An example of this are the acquisitions of radio stations by Clear Channel Communications, a company that already owns more than 1,200 radio stations. This concentration of radio station ownership results in economies of scale in operation resulting in greater efficiency and market power.

In a vertical merger, an acquiring company purchases a company, which provides input materials or purchases output material from it. This has been very common in the communications industry where there has been a perception of a software or programming shortage or “bottleneck.” Exam- ples of vertical mergers are the Disney (software and programming) acquisition of Cap Cities/ABC (distribution company) and the merger of Time Warner (cable and content) with America Online (Internet and online distribution).

A conglomerate is a company that owns a portfolio of businesses. Follow- ing the M&Aactivity of the past decades, virtually all large media companies are conglomerates in that they own a portfolio of companies (Columbia Jour- nalism Review, 2002). In addition true conglomerates also own media proper- ties, such as General Electric’s ownership of NBC. The degree of synergism or scale economies between the portfolio companies own can be significant, but the key reasons for conglomeration are the cash flow of individual companies and the benefit of owning a diversified portfolio.

Prior to the successful completion of a merger or acquisition, the transaction is subject to regulatory approval. A combination or acquisition can be blocked by the Department of Justice (DOJ) or the Federal Trade Commis- sion (FTC) under antitrust law. In some cases communication companies are subject to additional oversight from the Federal Communications Com- mission (FCC).

The implementation of a merger, or the integration of two companies is often a complicated process. This is where the theory of finance meets the reality of operations. Often the meshing of different operations and different corporate cultures produces diseconomies and unanticipated prob- lems. However, if all goes according to plan, the combined companies become more valuable than the separate companies, and the shareholders of the acquiring company are rewarded with a higher stock price. If the combination does not go according to plan, the shareholders of the acquiring company will likely face a lower stock price. Two to three years after the transaction this was the case for two very high-profile media transactions: the AOL-TimeWarner merger and the AT&T acquisition of two of the three largest cable television operators, TCI and MediaOne (The Economist, 2002).

OZANICH AND WIRTH

Media Industry M&A Activity (1987–2002)

The data concerning communications industry transactions are difficult to delineate. Many transactions may be between privately held companies where there is no requirement of public disclosure. In addition, if nonpublic securities (i.e., Rule 144A Private Placements) are used to finance the transactions, no public documents or details will be filed with the SEC. Finally, the definition of media or communications industry varies greatly by data collector.

According to Thomson Financial, the media industry accounted for al- most $1.1 trillion in M&A activity during the period from 1987 to 2002. Ta- ble 3.1 provides a summary of these transactions based on Census Bureau SIC Codes for the broadcast, cable television, newspaper, publishing, and the motion picture production and distribution industries.

Further, many of the communication industry transactions were “megadeals.” These transactions were for assets carrying very high valua- tions. Table 3.2 provides a summary of the 10 largest M&A transactions in the media industry. Besides these megadeals there have been a large num- ber of other media mergers and acquisitions from 1987 to 2002.

THE ECONOMICS OF MEDIA MERGERS AND ACQUISITIONS