This week is shaping up to be a busy one for investors. Amid the continued earnings reports and economic data that sit on our investing plate, we now have a potential musical chairs game of mergers and acquisitions (M&A) activity on our hands. I’m referring to the announcement that Verizon Communications (VZ) is acquiring AOL (AOL) in a $4.4 billion transaction. If you were an AOL shareholder, you saw an instant pop in your investment to $50 from the closing price of $42. Congratulations to you and other AOL shareholders.
My concern, however, is this deal will ignite some sloppy behavior based on what could happen rather than sticking with the tried and true strategy of investing based on the fundamentals and the shifting landscape of economics, demographics, psychographics, technology and other PowerTrend drivers. That said, I’m more than happy to have my Growth & Dividend Report subscribers benefit when a fundamental recommendation I make to them is the beneficiary of unexpected acquisitions. We saw that with Kraft Foods (KRFT). Even before its pending $16.50 special dividend, my subscribers are up almost 40% in that position.
This past semester, I taught a graduate class at New Jersey City University (NJCU) on M&A. When examining an announced M&A transaction, there are a number factors to consider. They include the strategy behind the buy, reasons why the target agreed to sell, expected synergies to be had from the deal and, of course, how the transaction is being paid for. Let’s break down this Verizon-AOL deal with those things in mind. Before we do, however, I have to point out that more often than not those millions and billions of synergy dollars are not fully realized. Years later, after the deal closes and the business is integrated, most tend to forget all those lofty promises. Let’s now delve into the Verizon-AOL deal.
Earlier this week, Verizon Communications announced its intention to acquire AOL for $4.4 billion or roughly $50 per share. Cited reasons for Verizon acquiring AOL include:
- Acquiring AOL would further its strategy to build out its Long Term Evolution (LTE) wireless video and streaming video strategy.
- AOL would contribute to its Internet of Things platform.
From AOL’s perspective, CEO Tim Armstrong cited the need for the company to be part of a larger player. Per comments from AOL’s Armstrong, Verizon has 1.5 billion connected devices in the United States and it touches 70 percent of U.S. Internet traffic.
From my perspective, we can read in the press release that “Verizon’s vision is to provide customers with a premium digital experience based on a global multiscreen network platform,” but what does that mean?
While we all expect Internet connectivity 24/7, it’s what we do with that connectivity that matters. Given moves by other companies that are going after the top services, such as Apple (AAPL) TV and its iTunes services that enable consumers to buy TV shows, movies and more, cable companies need to prevent themselves from becoming a dumb pipe that loses content revenue to other services. We’re starting to see that happen as consumers unplug from phone and TV services in favor of just higher-speed broadband that’s used to access digital content from other services and devices. Why use a messy Verizon FiOS interface when, with two clicks, I can stream a movie via my Apple TV from Netflix or Apple? A simple USB jack lets me stream Amazon’s proprietary Bosch series over my FiOS connection.
Verizon’s move is far from surprising, given the earlier move by Comcast (CMCSA) to acquire NBC Universal, a shift that added competitive moats around the cable and Internet business by layering in content. Even that deal echoed the Disney buy of ABC/Cap Cities back in 1995. It’s no secret that content is a competitive differentiator – just look at the moves by Netflix (NFLX) and Amazon.com (AMZN) to distinguish themselves from other streaming services.
The big question to me is: what does merger this mean for AT&T (T), Charter Communications (CHTR), Time Warner Cable (TWC), Cablevision (CVC) and other cable companies, as well as digital properties Yahoo! (YHOO) and Hulu? I also wonder what the deal means for other content companies such as Twenty-First Century Fox (FOXA) and others. My suspicion is that M&A mania is likely to pop the shares of those companies as herd thinking takes over and, as tends to happen, we see a game of musical chairs unfold.
While it is tempting to jump in, my recommendation would be to buy a company’s shares based on the business, not hopes for M&A activity. It is better to be safe than sorry that you’re left owning the last player standing. Rather than rush to buy a potential takeout candidate, let’s instead think about why Verizon is making this move. Add in Cisco’s 2015 Visual Network Index that calls for digital streaming traffic to simply explode further over the next few years. Per that report, mobile video will increase 13-fold between 2014 and 2019, accounting for 72% of total mobile data traffic by the end of the forecast period. Factor in Cisco’s bullish view on global cloud traffic — annual global cloud IP traffic will reach 6.5 zettabytes (or 541 exabytes per month) by the end of 2018, up from 1.6 ZB per year (137 EB per month) in 2013. We can understand why Cisco sees data center traffic tripling between 2013 and 2018.
I see that underlying driver, which fits nicely into my Always On, Always Connected PowerTrend. I look for a key technology supplier that benefits from the coming opportunities as the cable companies, data centers, and so on deal with the eventual pain points as we consume more and more and more digital content. Earlier this week, I recommended that my Growth & Dividend Report subscribers add a certain technology company to their holdings to profit from just such a pain point. To learn what this new recommendation was, subscribe to my Growth & Dividend Report.
In case you missed it, I encourage you to read my e-letter column from last week about how some euro zone economies are gaining momentum. I also invite you to comment in the space provided below my Eagle Daily Investor commentary.
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