Optimize deals

Megadeals transforming the entertainment, media and communications sector

Strategies for game-changing success in M&A

A publication from PwC’s Deals Practice

When AT&T closed its $49 billion acquisition of DirecTV in July of 2015, the combination created one of the top U.S. content distributors. The deal showed AT&T’s determination to diversify their U.S. wireless and wireline business--where market saturation and competition has slowed growth--to gain more scale and leverage in television to offer new video services. “We’re now a fundamentally different company,”¹ AT&T Chief Executive Randall Stephenson reported to the market at the time.

The AT&T acquisition exemplifies the kind of megadeals that are now regularly occurring in the Entertainment, Media and Communications (EMC) sector as companies rush to adapt to the substantial changes sweeping the industry. Not too long ago, the boundaries between content creation, content aggregation, and content distribution were clear with well-defined business models.

Content creators sold content to packagers, who made subscription-based deals with distributors, who sold subscriptions to consumers. And to complement the lucrative subscription model, both packagers and distributors also sold advertising. It was a simple and very profitable value chain.

Over the past five years that business model has been upended, paving the way for new EMC players to enter the industry that were traditionally technology companies. Technology innovations, particularly the shift to digital, are rapidly and radically changing consumer behavior by allowing consumers to tap into content on demand.

Increasingly, consumers are cutting cords with traditional cable companies and paying for content directly from the packagers or content providers, cutting out distributors who are responding by offering consumers slimmed down, cheaper subscriptions tailored to their tastes. This fundamental shift in consumer behaviors has accelerated the industry’s race for content since anyone on the value chain can now reach the end customer.

2 Megadeals transforming the entertainment, media and communications sector

“We’re now a fundamentally different company” 1

AT&T Chief Executive Randall Stephenson reported to the market at the time

1 Bloomberg Technology, AT&T Completes $48.5Billion DirecTV Buy With FCC Approval, July 24, 21015,

Exhibit 1: Top ten megadeal acquirers by $ value (2011-1H 2016)

Acquirer Sample acquisitions

Estimated public deal value ($B)

Announcement date Close date

Days from announcement to close

Verizon Communications

Verizon Wireless 130.1 9/02/2013 2/21/2014 172

AOL 4.4 5/12/2015 6/23/2015 42

XO Communications –Fiber Business

1.8 2/22/2016 Not Yet Closed Not Yet Closed

CharterCommunications

Time Warner Cable 60.0 5/26/2015 5/18/2016 358

Bright House Networks 11.4 3/31/2015 5/18/2016 414

Optimum West (Cablevision) 1.6 2/07/2013 7/01/2013 144

AT&T DirecTV 49.0 5/18/2014 7/27/2015 435

Iusacell 2.5 11/7/2014 1/16/2015 70

Nextel Mexico 1.9 1/26/2015 4/30/2015 94

Leap Wireless International 1.2 7/12/2013 3/13/2014 244

Liberty Global Virgin Media 24.0 2/05/2013 6/07/2013 122

Cable & Wireless Communications

7.4 11/16/2015 5/16/2016 182

Altice Cablevision 17.7 10/27/2015 6/21/2016 238

Cequel Communications (Suddenlink)

9.1 5/20/2015 12/21/2015 215

Microsoft LinkedIn 26.2 6/13/2016 Not Yet Closed Not Yet Closed

Facebook WhatsApp 21.8 2/19/2014 10/06/2014 229

SoftBank Sprint Nextel 21.6 10/15/2012 7/10/2013 268

Comcast NBC Universal Media 16.7 2/12/2013 3/19/2013 35

DreamWorks Animation SKG

3.8 4/28/2016 Not Yet Closed Not Yet Closed

Frontier Communications

Verizon Communications –Wireless Operations

10.5 2/5/2015 4/1/2016 421

S New England Telephone Co 2.0 12/17/2013 10/24/2014 311

Note: Table includes sample megadeals. Megadeal defined as deal value of over $1B

Source: Capital IQ, Reuters (initial announcement deal value). Note that select deal values have been updated based on final press release/public information available

Major media companies, including Charter Communications, Verizon Communications, AT&T and Altice have made multiple megadeals over the past several years (see Exhibit 1). While it may be true that megadeals have transitioned these companies into fundamentally different entities, it is also true that transformation became necessary given the disruption caused by technology making this a fundamentally different sector.

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$18

$62

$202

$149

$135

$59

2011

2012

2013

2014

2015

1H 2016

Exhibit 2A: Total megadeal value by year

*

Exhibit 2B: Total number of megadeals by year

8

17

14

16

19

16

2011

2012

2013

2014

2015

1H 2016 *

Total megadeal value by year, 2011-1H 2016, in US$ billions

Total number of megadeals by year, 2011-1H 2016

A new megadeal taxonomy

The nature of deal-making in the EMC sector, particularly involving megadeals, convinced us to take a closer look at the types of EMC sector megadeals, how to consider their value creation potential, and therefore how to manage their integrations to realize success and increase value.

To get a handle on the megadeal universe, we kicked off our research by analyzing representative EMC megadeals (which we defined as those where the target/acquired business was an EMC company) of at least $1 billion in size that were initially announced from 2011 through June 2016. We found 90 such transactions worth a combined $624 billion. Between 2011 and 2015, the number of megadeals each year was fairly steady. For example, there were 17 deals in 2012 and 16 in 2014. However, halfway through 2016 there were already 16 megadeals, a sign that deal volume might be gaining steam. We also noticed that total annual EMC megadeal value spiked in 2013 and was relatively steady in 2014 and 2015 ($149 billion and $135 billion respectively), as already large companies brought more parts of the EMC value chain under one roof. (See Exhibit 2A, 2B and 2C representing megadeal value, volume and average value by year).

4 Megadeals transforming the entertainment, media and communications sector

$2

$4

$14

$9

$7

$4

2011

2012

2013

2014

2015

1H 2016

Exhibit 2C: Average megadeal value by year

Average megadeal value by year, 2011-1H 2016, in US $ billions

Note 1: Includes all megadeals announced: Closed, failed, and not yet closed (pending regulatory or stakeholders approval). Years shown are by deal announcement date.Note 2: 2016 data is through 1H 2016.Source: Capital IQ, Reuters

*

Our research also found some interesting trends among the various EMC subsectors. In 2012 and 2013, the communications subsector generated the most megadeal volume. However, as technology changed and margins compressed for cable operators, deal activity in that subsector began to dominate. As part of our research to better understand megadeal activity we categorized each deal, across all subsectors, into four different deal types and motivating factors (see Exhibit 3, classified based on acquired company):

1. Consolidation

2. Capabilities Extension

3. Innovation

4. Content

We also identified a fifth deal category, the Stake/Ownership deal, in which a wealthy individual or group buys a particular EMC “property” (casino or sports team). These deals accounted for five percent of the total EMC megadeals.

2 Forbes, Charter and Time Warner Cable deal promises your Internet bill won’t look like a smartphone plan; April 25, 2016

Consolidation

Consolidation deals are the most common, accounting for more than two-thirds of megadeal value in the EMC sector. These deals often involve competitors, value chain participants or companies with closely adjacent products and overlapping customers. The goal is to unlock value by cutting costs and improving efficiencies. Consolidation deals tend to be relatively successful as the companies know each other well and the synergy potential is significant and usually obvious. The communications and cable subsectors have been rapidly consolidating in recent years (e.g. Frontier/AT&T; Altice/Cablevision), with Charter Communications being one of the most active, announcing three megadeals in the last five years. Although stepped up regulatory scrutiny about the competitive effects of consolidation has slowed the pace of these deals, Charter won approval for Time Warner Cable by making several key concessions: a commitment to network neutrality for seven years; no data caps or prohibitions against content providers going to competitors; and a commitment to expand infrastructure.2

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Exhibit 3: Motivating factors (2011-1H 2016)

Megadeal value share by category (2011-1H 2016)

Note: Includes all megadeals announced: Closed, failed, and not yet closed (pending regulatory or stakeholders approval).Source: Capital IQ, Reuters

$624 BillionTotal Value

Innovation, 5%

Capabilities Extension, 20%

Consolidation, 65%

Content, 6%

Consolidation deals accounted for

more than 2/3 of megadeal value in the

EMC sector

Other/Stake Ownership, 5%

Capabilities extension

These deals are the second most common, accounting for 20 percent of deal value from 2011 – 1H 2016. Capabilities Extension deals typically involve two large, mature companies. The buyer is usually aiming to scale up and is seeking new products, new talent or new customers in a large, tangential market where it doesn’t already possess the capabilities to compete (Verizon/AOL as an example). Interestingly, the majority of megadeals in the advertising and marketing subsector—such as the Publicis acquisition of Sapient—have been capability extension deals. Some of the most effective growth opportunities have been to sell a greater variety of services to the same block of customers.

Capabilities Extension deals accounted for 20% of deal value from 2011 – 1H 2016

6 Megadeals transforming the entertainment, media and communications sector

Innovation

These deals typically involve a large, mature company that acquires a smaller, recent start-up to bring new technology or a block of customers into the business to create or enhance competitive advantage. Innovation deals, which are a specific type of capabilities extension, command a high value but are smaller and less complex from an organizational standpoint (although they still experience challenges integrating technology, culture, products, etc.). The acquired company tends to have a new, sometimes disruptive technology that often drives new consumer behavior and/or extending customer reach. Most of these deals have occurred in the Internet and Information subsector, where new tech entrants are constantly emerging (see Exhibit 4). Examples include LinkedIn/Lynda and Facebook/WhatsApp.

Innovation deals command a high

value but are smaller and less complex from an organizational

standpoint

Exhibit 4: Overview

Megadeals value by sector and category, 2011-1H 2016, in US$ millions

0

50

100

150

200

250

Publis

hin

g

Mu

sic

Re

cre

atio

n&

Leis

ure

Ca

sin

os

& G

am

ing

Film

/Conte

nt

Advert

isin

g&

Ma

rketing

Inte

rnet

and

Info

rma

tio

n

Bro

adcasting

Ca

ble

Co

mm

unic

atio

ns

Consolidation Capabilities Extension Innovation Other/Stake Ownership Content

Note: Includes all megadeals announced: Closed, failed, and not yet closed (pending regulatory or stakeholders approval).

Source: Capital IQ, Reuters

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Content

These acquisitions are designed to enhance the content portfolio of a media company. Disney’s acquisition of Lucasfilm is a good example. The broadcasting subsector is particularly focused on content acquisition to combat declining revenue. After a quiet 2014 and 2015 in Content megadeals, 2016 has already been a strong year with three deals through 1H 2016 (including Lionsgate/Starz and NBCU/DreamWorks) with total value of $10.5 billion. Content is still “king” and remains a consistent value driver in this changing sector.

Geographic expansion

One notable theme that cuts across the four deal categories is (limited) geographic expansion. Only 19 of the 90 EMC megadeals announced between 2011 and 1H 2016 had cross-border implications, and their numbers have been decreasing. Cultural, language and regulatory challenges, including the cross-border management of content rights, have reinforced that EMC can be regional in nature, causing limitations in opportunities for global expansion. An exception is cable and broadcaster, who may face less regulatory challenges and are expanding globally in response to competitive pressure and growth in emerging markets. During the analysis period, a third of geographic expansion deals were in the cable subsector and more may come. Active players include UK based Liberty Global (which purchased US-based Cable & Wireless Communications) and Netherlands-based Altice (which purchased Cablevision and Cequel Communications/Suddenlink).

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Avoiding the seven megadeal pitfalls and positioning your company for success

Corporate leaders experienced in mergers and acquisitions are well aware of the risks if a transaction does not live up to expectations. Many companies have honed deal-related processes and playbooks that serve them well when executing relatively small to mid-sized deals. However, we have observed that megadeals in the EMC sector pose a unique set of challenges along the value chain, particularly with people, technology platforms, and partnerships, often creating barriers to success that are challenging even to executives with significant acquisition and integration experience.

When executed correctly these transactions can propel a company ahead of competitors by creating formidable capability platforms, realizing significant operational efficiencies, and opening up new avenues for growth. For example, T-Mobile’s 2012 acquisition of MetroPCS yielded total synergies even greater than forecast ($9-$10 billion actual as compared to $6-$7 billion forecast), and almost two years ahead of schedule.3

To succeed, experienced leaders should make adjustments to navigate the specific challenges associated with megadeals. We have

identified seven critical challenges and how to address them. Each of the seven critical challenges apply to the four EMC deal categories—Consolidation, Capabilities Extension, Innovation and Content—although the degree of the challenge varies by deal type.

3 Telekom Capital Markets Day Presentation, February 26-27, 2015

1

Assigning accountability

2

Retaining and relying on acquired

management

3

Valuing cost and revenue

synergies

5

Doing more diligence

6

Communicating effectively

4

Tailoring the playbook

7

Manage the transaction

as a business process

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It is critical that leadership focuses on both the revenue driving and cost cutting aspects of the deal —and holds the correct internal parties accountable. There is a tendency among acquirers in the EMC sector to focus primarily on the revenue opportunities after a purchase, aligning content, leveraging valuable IP and renegotiating distribution agreements. However, success can also depends on back-office optimization—the less glamourous work of consolidating finance and accounting functions for example. Accountability should be assigned in both areas.

In a leading acquisition scenario, there is an obvious business unit (BU) leader who can drive the transaction as the acquired operations fall within his or her current scope. A particularly strong BU leader evaluates the technology, the customers, the marketplace, and core business functions of the target company. What’s more, the BU leader may take ownership of the integration and the combined performance plan. Consolidation oriented deals tend to naturally include strong business unit accountability due to the high degree of operational overlap.

In an EMC megadeal it can be more difficult to identify strong integration leaders from the business unit for two reasons. First, there may not be an ideal leader to focus on both revenue opportunities and back-office optimization, so multiple leaders may need to be assigned and held accountable. Second, particularly with Capabilities Extension deals, the acquired business is new to the company and so an internal leader may not be obvious. In this leadership vacuum, the CEO often becomes solely accountable for the deal’s business success, which presents significant challenges to evaluating the business logic and executing post close.

We have seen CEOs take a number of different approaches to EMC megadeals and generally observed that the more effective deals tended to involve a combination of the following:

• Enhanced functional accountability – Empower c-suite leaders in technology, sales and marketing, content, operations, and corporate functions, and make it clear to them that they are accountable for quantification, execution, and delivery of synergies in their areas.

• Increased board governance – Risks arise when the CEO champions or directly leads the transaction; a board member should assume a co-leadership role, and the board should more actively participate throughout the acquisition process, perhaps making greater use of external professionals during the evaluation and execution phase.

1 Assigning accountability

2 Retaining and relying on acquired management

Retention is particularly important for Innovation and Content deals where knowledge about a new technology and/or intellectual property is held by a small group of creative and/or technology leaders. Losing a key executive can hurt the value of the deal and ripple into further loss of key staff. As a result, the acquirer must understand the “special sauce” and culture of the company, as well as the nature of employment contracts, which are an especially significant factor in Content deals.

Acquired management is also important for Capabilities Extension deals where the company is buying large operating units and should have experienced managers in place from day one to make certain the operating units continue to run smoothly.

Reliance on acquired management poses a dilemma since the senior team from an acquired company often can afford to leave after the deal closes and may have other opportunities given the especially tight-knit nature of the sector. They may also simply dislike the idea of running a business unit in the new company after running the acquired company. Considering this reality, the acquiring company should assess how much it will rely on these senior managers and for how long, and build relationships with the second level and other sub-line leaders at the acquired company who might be able to step in and run the business unit on a longer-term basis.

10 Megadeals transforming the entertainment, media and communications sector

Past megadeals have shown that cost synergies are more achievable than revenue synergies. For valuation purposes it is therefore a practice to overweight cost and underweight revenue opportunities. This point is particularly true for Consolidation plays, where two mature companies are coming together and the cost synergies are quantifiable and attainable.

Cost synergies do come with a fair share of challenges to achieve. For example, rapid technology changes often create a platform dilemma for companies. Different types of technologies and workflows exist across the sectors as a result of evolving set-top box technology, the shift from analog to digital as well as from linear to non-linear content workflows, and rapidly evolving video delivery platforms. This very complex environment offers an opportunity to streamline and eliminate duplicative processes and technology. Along similar lines, EMC companies may have fairly informal and inefficient back office processes that can be streamlined to improve efficiencies across the enterprise. These factors can make integration activities difficult but rewarding.

On the revenue synergies front, it is a particularly tough to achieve and measure revenues tied to a big new strategic vision, or long-term assumptions that require technology integration or changing customer behavior over many months or years. Such assumptions, which are frequently baked into Capabilities Extension deals, often don’t materialize, materialize more slowly than expected, or materialize on a smaller scale. If the acquisition thesis is dependent on revenue, leaders should push for even more granular detail during due diligence, along with considering alternative scenarios and outcomes, design a separate process within the integration to carefully manage revenue goals, and focus intently on driving revenue synergies as quickly as possible.

Many acquisitive companies have developed extensive M&A playbooks and invested in internal M&A capabilities to execute and integrate “tuck-in” deals. However, these playbooks may not be useful for megadeals. In particular, Innovation deals, with their huge valuations, narrow focus, tiny revenues, and entrepreneurial management, may force an acquirer to toss out its playbook.

For the Consolidation and Capabilities Extension deals, companies should supercharge their standard M&A playbook. Given the size and complexity of these deals, their unpredictability, and the higher volume of requirements across the enterprise necessary to execute these transactions successfully, leaders should step back, start with a clean sheet of paper and tailor the integration approach to the specifics of the deal at hand.

For example, the operational playbook for integrating a Consolidation merger among Communications companies should accommodate what may be a unique and highly complex network and engineering transition. In the Media and Entertainment space, content distribution agreements are key and integration teams should think carefully about how they will renegotiate these agreements. Across the sector, the acquirers should consider how revenue will be tracked (generated from advertising and licensing) and how this revenue aligns across the respective business units. This integration challenge can be especially complicated as new sources of revenue emerge across the Ad Tech space.

3 Valuing cost and revenue synergies

4 Tailoring the playbook

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Despite the size and complexity of megadeals, there is sometimes pressure to fast-track the due diligence. An attitude often prevails that big public companies, with their sophisticated institutional investors, legions of regulators and audited financials have less to hide than small companies and thus require less due diligence. Other times senior leaders worry about slowing down the deal process and losing momentum by digging too deeply. Confidentiality issues are also cited as a reason to curtail due diligence, and there can be uncertainty about the depth of due diligence that is legally permitted.

The net result is that companies involved in megadeals often know surprisingly little about each other. A lack of due diligence may not matter too much in the case of an Innovation deal since the target company is small and the potential for due diligence is limited. But a lack of due diligence can be quite damaging for Capabilities Extension deals if cost and revenue assumptions are not properly vetted. Before signing on the dotted line always ask the question: "What didn't we validate?" and make sure you can live with the risk.

For EMC acquirers this added due diligence is particularly relevant in three areas, across various sub-sectors. Media and Entertainment companies should understand what content and intellectual property the company will own, how to leverage it, and its value. Communications companies should understand the age, complexity, and required maintenance associated with the network/core infrastructure being purchased. Across sub-sectors product alignment and rationalization pose challenges.

5 Doing more diligence

Good external communications from the moment a deal is announced is critical to explain the benefits of the deal to customers; this point is especially true for Communications and Cable companies, which often have difficulty with customer loyalty and revenue retention through periods of change. Internal communication is also key when joining two very different cultures, particularly in Innovation and Capabilities Extension deals. For example, forcing the culture of a “legacy” Communications company on an Ad Tech or Internet and Information company may be disastrous; leadership should consider a well-structured and thoughtful internal communications plan to put both sides at ease.

Where the company focuses its communication efforts may vary by deal type. For example, Consolidation deals tend to create a lot of anxiety and dysfunction among employees worried that “cost synergies” translates into “lost jobs.” The senior team should lay out the integration strategy for itself in a detailed way so it can communicate confidently to employees--especially key employees whose jobs are secure. An inability to communicate intentions clearly and consistently inevitably creates uncertainly in people’s minds. Instead of focusing on deal execution, people begin to focus on personal survival.

By comparison, employees in Innovation deals are often less concerned about job security since they hold the critical intellectual capital the acquiring company wishes to retain. In these deals, a greater emphasis is often placed on communicating with investors and Wall Street who may be focused on a very high price tag.

6 Communicating effectively

12 Megadeals transforming the entertainment, media and communications sector

The larger the transaction, the more challenging the integration and the greater the desire for a well-defined business process to focus resources and capital on the right activities at the right times to capture cost and revenue synergies as quickly as possible. This is especially true for both Consolidation and Capabilities Extension deals where two big companies are coming together with a large number of employees and customers.

It’s helpful to remember that the deal process has an inherent flaw: the original valuation is by necessity based on assumptions. After the deal is announced those assumptions cannot be automatically accepted as fact. Once the company gets access to people and additional information at the target company, the acquirer must put a tailored business process in place with the requisite accountability and transparency to get data and test assumptions with fact-based analyses, and then make further decisions based on those analyses.

The business process for these types of deals must include a clear set of guiding principles and goals connected to sustaining everyday operations and capturing synergies, and relentlessly focus on quantifying, reporting and executing on value capture opportunities. What’s more, the process must empower leaders to keep the integration on track by giving them latitude to make quick decisions regarding organization, people, customers and priorities--and hold these leaders responsible for communicating those decisions to customers, employees, shareholders and partners.

In the case of an Innovation deal, the integration should be handled more like a relationship and less like a business process. The smaller, entrepreneurial team from the target company usually desires a more personal touch to keep them engaged post close.

7 Manage the transaction as a business process

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Conclusion

On July 25, 2016 Verizon announced the acquisition of Yahoo for $4.8 billion, a blockbuster deal that Verizon intends to integrate with its existing AOL business, significantly enhancing its portfolio of media content properties and Ad Tech capabilities.4 This megadeal is a prime example of how the traditional lines between media, communications and technology are blurring as Verizon encompasses all three of these sub-sectors within one company and consumer offering.

With more deals of this nature on the horizon, we expect that over the next three to five years the delineation

between these sub-sectors will continue to blur and perhaps even fade. In the near term, Consolidation deals may slow in volume, while Innovation, evolving Capabilities Extension deals, and an ongoing race for Content will continue to power megadeals. To help realize the continued transformation of the sector, it will be increasingly important these deals are successfully executed through thoughtful and skillful integration. In the end, it will likely be technology that will drive the continued transformation of this sector into an exciting future.

4 Verizon, News Release, July 25, 2016, http://www.verizon.com/about/news/verizon-acquire-yahoos-operating-business

14 Megadeals transforming the entertainment, media and communications sector

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Gregg Nahass

Partner, PwC's Deals Practice, US and Global Leader, M&A Integration213-356-6245gnahass@pwc.com

Paul G. Kennedy

Principal, PwC’s Deals Practice, EMC Deals617-530-5288paul.g.kennedy@pwc.com

Lori Bistis

Director, PwC’s Deals PracticeEMC Deals617-530-6059lori.m.bistis@pwc.com

For a deeper discussion on deals or for more information on this publication please contact one of the following individuals:

Contact us

Tom Rooney

Partner, PwC's Deals Practice, EMC Deals Leader646-471-7983thomas.rooney@pwc.com