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U.S. telecommunications company AT&T is having a tough time completing the acquisition of Time Warner, as the U.S. government is fiercely opposing the transaction on antitrust grounds. The logic behind blocking a transaction leading to vertical integration has been a matter of debate, but the U.S. Justice Department has challenged the merger in court, potentially leaving both companies vulnerable to an activist attack if the deal falls through.

To be sure, Time Warner has already faced activist demands, with Keith Meister’s Corvex Management rumored to have pushed for a sale or HBO spinoff in 2016. Corvex exited Time Warner in February, but it may consider making another move if the AT&T deal fails to materialize. AT&T has not been targeted before, largely thanks to its market capitalization of $212 billion. However, with activists developing a taste for targeting large market-cap companies – Third Point Partners at Nestlé and Trian Partners at P&G representing the most remarkable examples – AT&T may also fall vulnerable to an activist assault, irrespective of whether the deal completes or not.

CORD-CUTTING NIGHTMARE

According to Activist Insight Vulnerability, both companies have a high risk of being targeted by an activist, although Time Warner is a bit more vulnerable. AT&T has a vulnerability score of 53.6, with performance, growth and profitability among the biggest issues facing the company. To offset slow growth, the company has embarked on an acquisition binge, splurging $48 billion on broadcast satellite services provider DirecTV in 2014 at a time when the “cord-cutting” trend was just catching on. Subscription sales at the DirecTV unit disappointed following the acquisition, while the debt increased substantially.

The company’s profitability is also falling behind. According to Vulnerability, AT&T’s gross margins of 65.5% are consistently below peers’ 54%. The difference between net operating margins is smaller but still high at more than 2 percentage points.

An activist may seek to stall the company’s M&A strategy and push for a focus on the bottom line and deleveraging. Indeed, credit rating agency Moody’s warned it may downgrade the company’s bonds if the Time Warner deal succeeds as AT&T’s debt may rise from around $115 billion to $180 billion.

Yet an activist investor could emerge even if the government blesses the deal. At $107 per share at the time of the merger announcement, Time Warner is too expensive, despite the strategic benefits of acquiring a vertical supplier. In the five days following the October 2016 announcement, AT&T’s stock dropped around 7%, while the S&P 500 posted flat gains, indicating investors believed the company was overpaying for Time Warner.

CROWN JEWEL

Time Warner has a vulnerability score of 55 and its chief weaknesses are low director support and high activist ownership, according to Vulnerability. The TV company counts among its shareholders around 19 partial or dedicated activists, including Third Point Partners, SpringOwl Asset Management, Sandell Asset Management and Fir Tree Partners.

At the last annual meeting in June, a host of directors received low approval from shareholders. Harvard professor Robert Clark, director since 2004, and Axel Springer CEO Mathias Döpfner, appointed in 2006, were the least liked directors, each receiving 90% and 92% of the votes, respectively.

The HBO spinoff could re-emerge as a demand from an activist shareholder, who could argue that the Game of Thrones creator may be better positioned to compete on a standalone basis with Netflix and Amazon. HBO’s on-demand service HBO Now is way behind Netflix and Amazon in terms of geographic expansion and it spends much less than its rivals on content, although it constantly releases hit shows. Eric Jackson, former managing director at SpringOwl and founder of EMJ Capital, believes HBO’s failure to expand internationally will result in an expensive competitive loss. “HBO is in that position that if it doesn’t go global, it will probably be boxed out in many important countries because they’ve chosen to wait and collect the profits upfront from licensing deals,” Jackson said in a December podcast.

Netflix’s market capitalization is $15 billion higher than Time Warner’s and HBO generates just a third of the revenues. Netflix’s sales in 2016 were $8.8 billion, around $3 billion more than HBO’s. This suggests investors value Netflix as a growth company and HBO as a mature company, yet an activist might contend there is a lot of value hidden in HBO Now.

AT&T may get some respite from activist investors, as shareholders wait to see whether CEO Randall Stephenson’s acquisition-focused strategy will bring results. Time Warner may not have that luxury, as there are clear avenues to unlock value now through a carve-out.