Time Warner Dares Murdoch to Bid Beyond What He Can Afford

Jul 25, 2014 8:56 am ET

(Updates with Sky deals in 27th paragraph. See EXT3 <GO> for more on Murdoch’s Time Warner bid.)

July 25 (Bloomberg) -- Time Warner Inc.’s board is daring Rupert Murdoch to make an offer he can’t afford.

In rejecting an $85-per-share takeover bid by Murdoch’s 21st Century Fox Inc. last week, Time Warner said its own growth plan “is superior to any proposal that 21st Century Fox is in a position to offer.”

That language -- “in a position to offer” -- was no accident. After evaluating Fox’s books, Time Warner concluded that Murdoch would be uncomfortable financing a deal above $100 a share, people familiar with the matter said. The purchase would require so much borrowing it could sacrifice Fox’s credit rating, or use so much stock that existing investors’ holdings would diminish in value, said the people, who asked not to be identified because internal deliberations are private.

Convinced the media company was worth at least $100 a share based on future earnings, Time Warner’s board decided it won’t begin talks at much less than that number, the people said. Fox isn’t currently planning to bid more than $90 to $95 a share, according to a person familiar with Fox’s position.

“We remain of the strong opinion that TWX is likely to successfully maintain a ‘just say no’ defense at any price level that Fox could reasonably come up with,” Doug Creutz, an analyst at Cowen & Co. who has been following the media industry for a decade, said in a note to clients this week.

Higher Bids

Time Warner’s view is supported by credit-rating agency Standard & Poor’s. It estimates that Murdoch, 83, can add cash to raise the offer to no more than $93 a share without risking a downgrade to junk. The agency said it hasn’t set a limit on how high Murdoch can go to maintain investment grade. Moody’s Investors Service, however, concludes Fox could lift its bid to $105 a share -- borrowing as much as $21 billion -- while still remaining investment grade.

“In combining the two, it would be fair to assume it can take on a little more leverage -- but not too much,” Chris Valentine, a credit analyst for S&P, said in a phone interview. He added that the combined company could take on more debt than either can by itself.

The $85-a-share cash-and-stock offer valued New York-based Time Warner at about $75 billion, excluding options that could raise the total equity value to $80 billion. Each dollar per share that Murdoch raises his bid costs almost $1 billion.

After receiving a bid from New York-based Fox on June 9, Time Warner’s board spent weeks evaluating potential higher bids because it assumed Murdoch would be aggressive, said one of the people. The analysis, based on a multiple of Time Warner’s earnings, concluded any bid in the mid- to upper-$90s should be immediately rejected, the person said.

Upper Limit

The board also determined that Murdoch would be uncomfortable boosting the company’s leverage above 4 times earnings before interest, taxes, depreciation and amortization, according to people familiar with the matter. Based on that, the board calculated that Murdoch couldn’t offer the $100 a share or more that would prompt Time Warner to begin talks, the people said. Time Warner also wouldn’t sell to Murdoch without first running a broad auction process to see if there are other bidders, one of the people said.

In any deal for Time Warner, Fox’s goal is to keep its investment-grade credit rating, said a person familiar with the matter. The company is willing to increase its current offer while maintaining discipline on leverage and price, the person said. Borrowing at 4 times Ebitda isn’t a deal killer, the person added, if an analysis of Time Warner’s books justifies it.

Poison Pill

Time Warner’s board and executives have drawn lessons from Airgas Inc., which fended off a yearlong, hostile pursuit from Air Products & Chemicals Inc., according to one of the people. Air Products withdrew its bid after a Delaware judge upheld the packaged-gas supplier’s poison pill.

Time Warner’s board this week changed its bylaws to eliminate the right of shareholders to call a special meeting. That move delays any effort by Fox to replace the company’s board until the next annual meeting, which is typically held in June. Time Warner is also weighing whether to adopt a poison pill, according to two people familiar with the matter.

Time Warner’s board is now in control of the process, not shareholders, Bill Kavaler, an event-driven strategist at Olivetree Securities in New York, said in an interview.

“Fox needs to indicate that it is willing to pay a significant premium, that is something in triple digits, to get the board and Jeff Bewkes’ attention,” Kavaler said. “What you are seeing in the market is an expectation that, if this drags on, the bid will be very close to $100 per share. That is the base case. The bull case is for something over $100.”

Equal Value

Time Warner, the owner of CNN, HBO and Warner Bros., has fallen 3.8 percent in the past three days to $84.01 yesterday in New York. The shares traded as high as $88.13 on July 21, 24 percent higher than before the offer was made public on July 16.

Fox, whose units include the broadcast network, Fox News and the Los Angeles movie studio, gained 0.7 percent to $32.92 yesterday. It is down 6.5 percent since the bid was disclosed.

The fluctuations have left Time Warner and Fox with an almost identical market values of $74.1 billion and $74.8 billion, respectively. Options traders are buying up protection against a potential drop in Time Warner stock, wary of risks that include the board’s resistance to a merger and potential antitrust issues.

Other Suitors

There may be few other suitors for Time Warner. Verizon Communications Inc. Chief Executive Officer Lowell McAdam considered buying Time Warner and then passed, not wanting to take on additional debt after acquiring the rest of Verizon Wireless earlier this year for $130 billion, according to people familiar with Verizon’s discussions.

“From a strategy standpoint, we can get the rights to the content that will make us successful without needing to buy the content,” Fran Shammo, Verizon’s chief financial officer, said this week, without directly addressing whether there were talks.

By raising its bid, Fox may be able to avoid a costly and time-consuming fight. Securing a deal may require Fox to stretch to $105 a share, Moody’s analyst Neil Begley said in a July 21 report. Begley assumes 38 percent of the purchase is paid for in cash.

A bid of that size would value Time Warner at about $115 billion, including options and net debt. That’s about 15.3 times the company’s estimated 2014 Ebitda -- making it the most expensive takeover of a U.S. media company greater than $500 million since the start of the recession in 2007, according to data compiled by Bloomberg. The median Ebitda multiple for media acquisitions is 12.7, the data show.

Conserving Cash

If no assets were sold, Fox would need to borrow $21.2 billion to fund the deal, Moody’s said. That would put the combined entity’s total debt at 4.2 times earnings before interest, taxes, depreciation and amortization, above Moody’s target of 3 times for the current Baa1 rating, which is three levels above junk.

Fox now has about $19.1 billion in debt, or 3.2 times Ebitda, while Time Warner has $22.3 billion, or 3.6 times Ebitda, according to Moody’s.

With some asset sales, the new entity would have enough financial flexibility to retain Fox’s Baa1 rating, Moody’s said -- as long as the company can generate $5 billion to $7 billion in annual free cash flow and pledge that sum toward reducing leverage.

S&P’s Valentine said the cash part of Murdoch’s bid, now $32.42 a share, could be increased to about $40, bumping up the total bid to about $93 per Time Warner share, while still maintaining Fox’s investment-grade rating.

Sky Deals

That analysis assumed Fox is able to reap cash from selling its Sky satellite-TV assets in Germany and Italy, an agreement which was announced today. Fox will sell those pay-TV businesses to British Sky Broadcasting Group Plc for more than $9 billion. Another assumption was that Fox can secure an agreement to offload CNN once the deal is complete.

Should Fox decide to get more aggressive in its pursuit, it may have to reduce its 39 percent stake in BSkyB, said David Peterson, lead analyst for media conglomerates at Fitch Ratings.

Nathaniel Brown, a spokesman for Fox, declined to comment.

Another factor for the debt-ratings firms is how quickly Murdoch plans to pay down debt after the deal is done.

“Historically Fox has not done that,” Peterson said.

--With assistance from Alex Sherman, Caitlin McCabe and Scott Moritz in New York.