Climate’s Right for More Mergers

Easy access to inexpensive capital and strong equity returns are likely to keep the consolidation engine humming well into the future in media and entertainment, a new report said.

Ernst & Young’s 10th Capital Confidence Barometer: Media & Entertainment report surveyed 1,600 senior executives at public and private companies in 54 countries, including 61 senior managers from the media and entertainment sector.

It found a high level of optimism regarding the economy and a strong belief that debt and equity markets will continue to be favorable to the sector.

About 64% of the executives surveyed believe the overall global economy is improving, up from 59% a year ago.

More executives are confident about closing deals (33%) compared with a year ago (23%). Coupled with a narrowing gap between how buyers and sellers value deals, this is creating momentum to get business done.

Access to inexpensive capital continues to be a major catalyst. Ernst & Young predicted debt will be a primary source of financing for companies looking to make deals. In the past six months, debt as a percentage of purchase price in acquisitions has increased to 51% from 25%, the E&Y survey said. Perhaps the greatest indicator of the industry’s confidence in credit and financing availability is that 51% of executives surveyed plan to use debt as the primary source of deal financing during the next year, versus 21% a year ago.

And 98% of respondents expect deal volume to be either flat or higher in the next 12 months, with 52% predicting deal sizes of $250 million or higher, compared with 21% the previous year.

On the cable side, EY Global Media & Entertainment Transaction Advisory Services Leader Tom Connolly said deals are being driven by available capital, strong equity pricing and a desire to combat rising programming costs with added scale. And many CEOs realize their past capital allocation practices need to change, he said.

“Over the past three years, large media companies have spent about $70 billion on [share] buybacks and dividends,” Connolly said. “At the same time, they’ve spent dramatically less on acquisitions [prior to Dec. 13]. Now what you’re starting to see happen is this reaction, which is, ‘Our strategy needs to change because we can’t keep driving appreciation of the market values of our companies based on a strategy that is a function of stock buybacks and dividends alone. Now we must address growth.’ ”

Growth through acquisition, that is.

The cable industry’s consolidation frenzy beginning last year drove stocks to record levels. Already this year Comcast has agreed to purchase Time Warner Cable in a deal valued at $69 billion and AT&T has signed on to acquire DirecTV in a transaction valued at about $61 billion. Charter Communications, which started the deal frenzy last June by pursuing Time Warner Cable, agreed to a complicated trio of swaps, spins and sales with Comcast (to be consummated after the Time Warner Cable deal closes) that will double its footprint to 8.2 million customers.

There’s also a healthy fear that low-interest rates can’t last forever, so companies should lever up to do deals before they inch higher. Connolly called that a factor, but pointed to several deals that primarily used stock instead of debt as a currency. Comcast is buying Time Warner Cable in an all-stock transaction, for example.

“These companies have been smart investors — they bought low and now they seem to sell high,” Connolly said, referring to Comcast and Time Warner Cable. “Look at the next steps that are being taken: they are going to a spin off a number of subs, they are going to put debt into that entity they spin off, they are going to sell subs and [generate] cash. At the end of the day, Comcast is going to be in a position where they will relever up debt that they will have issued as part of this deal. That’s because they know their rate structure today.”

Debt issuance is at an all-time high. About $1 trillion of leveraged loans were issued in the U.S. in 2013, Connolly said.

“There’s a tremendous amount of liquidity in the market and a tremendous amount of institutions and pension funds and so forth seeking yield that is gobbling up all that debt,” Connolly said. “This is a very friendly environment. I think you can still look at it and say this likely will not continue over the longer term, that it has a window that will close, so it’s best to take advantage of it now.”