The Walt Disney Co. is acquiring most of the assets of 21st Century Fox for $52.4 billion in stock, or $66.1 billion after the assumption of debt, creating a content behemoth that will have the power to reshape the sports and entertainment landscapes. Their combined heft will give them even more leverage over cable companies and internet service providers while strengthening their online video streaming services, according to experts at Wharton and elsewhere.
If the deal passes antitrust muster, Disney will get Fox’s film and TV studios, Star India and a 39% stake in Sky, 22 regional sports networks, as well as entertainment properties including “The Simpsons” and Avatar, cable networks FX and National Geographic and a controlling stake in online video service Hulu. Fox is retaining its national sports channel, its broadcast and news operations, local TV stations and the Big Ten sports network. While the merger would help Disney grow its annual revenues from its current $55.1 billion to $74.1 billion, Fox would downsize correspondingly from $29 billion to $10 billion, according to a Wall Street Journal report.
Herbert Hovencamp, a Penn Law professor who is also a Wharton professor of legal studies and business ethics, said the merger “will produce a much more powerful Disney, able to compete better with streaming services like Netflix and Amazon.” However, Hovencamp, who is an antitrust law scholar, expected the merger to attract “close review” from regulators, especially as it relates to competition among regional sports networks. (The deal would bring together Disney’s ESPN and various Fox sports networks.)
University of Michigan professor Erik Gordon agreed that the merger will help Disney regain some leverage in the digital world. “It’s about Disney getting back some power that is sort of slipping away in a world of cord-cutting and new technologies that make the traditional distribution of [channels] like ESPN less powerful.” ESPN has had ratings troubles of late as viewers drop their cable TV service and switch to online content.
The backdrop of the Disney-Fox deal is the Justice Department’s move to block the AT&T-Time Warner merger, which it sees as anti-competitive. While the Disney-Fox deal is characterized as a “horizontal” merger, or a union of two competing companies in the same business (content creation), the AT&T-Time Warner merger is a “vertical” deal between two complementary companies that can result in market power. (AT&T distributes content that Time Warner creates.)
“The trade-off to removal of net neutrality is going to be increased scrutiny of these types of mergers.” –Herbert Hovencamp
The Disney-Fox deal is about positioning the combined company better in a digital world, by beefing up their video streaming services to go directly to consumers, according Hemant Bhargava, chair in technology management at the University of California at Davis. Hovencamp, Gordon and Bhargava discussed the implications of the Disney-Fox merger plan on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
More Consolidation Ahead
A more powerful Disney with the Fox assets could trigger other such deals, according to Wharton professor of operations, information and decisions Jehoshua Eliashberg. “It is likely to lead to more mergers and acquisitions and fewer, but more powerful, competing conglomerates.” Eliashberg had predicted in a recent Knowledge at Wharton story that “Disney will grow the pie as well as obtain a decent share of it.” Hovencamp postulated that Netflix as the market leader in its space could find itself as a merger target.
The strategy behind Fox’s selling of its entertainment assets appears to be driven by a reluctance to remain a second-rung player in that industry. “Fox either had to get a lot bigger in entertainment and in streaming or get out,” said Gordon. “Being in the middle is exactly where you don’t want to be.” Fox decided that its path of becoming bigger was to sell to Disney instead. In the deal, Fox shareholders will retain a 25% stake in Disney.
Gordon traced Fox’s decision to retain its news businesses perhaps to an emotional attachment CEO Rupert Murdoch may have with this media, since his empire began with newspapers in Australia. “Fox did the right thing in focusing on its strengths in the news and sports businesses,” said Eliashberg. “I will not be surprised to see in the future Fox acquiring more companies and strengthening its position in these domains. However, they will face the challenge of enhancing their position in the content streaming space.”
Disney’s Video Streaming Strategy
As Netflix, Google, Facebook and Amazon strengthen their muscles in entertainment, Disney will be able to compete against them better with the Fox assets in its fold, notably with a bigger voice in Hulu. Its larger content repertoire would give Disney a more robust online video service, even as its bargaining power over ISPs grows.
Disney recently announced new online streaming services as well as “ESPN Plus,” a streaming service slated for spring 2018, and a Disney-branded service in the latter half of 2019.
With the Fox deal, Disney is gunning for the overseas market as well for its online streaming services, much like Netflix. Bob Iger, Disney’s chairman and CEO, told CNBC that he liked what Fox has done in delivering content to consumers in Europe and Asia. “Once you have a direct-to-consumer service, you want to go beyond the U.S. and capture a much bigger share of the [global] market,” said Bhargava.
But Disney has its work cut out in building closer ties with its consumers, according to Bhargava. “Disney will have to really learn how to be a consumer-focused company in the modern world of data analytics,” he said. He noted that Netflix has done a good job on that front. “Reaching the consumer is not simply about being able to offer a product directly to a consumer,” he explained. “Netflix has learned what consumers want, how it can better predict their tastes, and their preferences in individual shows.” Netflix has specialized in those areas early on, he added. “That is something that companies like Disney, which have been away from the consumer, has never built.”
Antitrust Issues
Hovencamp said the Disney-Fox transaction will get a close review, especially because of the dominance the combined company would get in sports networks.
“[The Disney-Fox deal] is likely to lead to more mergers and acquisitions and fewer, but more powerful, competing conglomerates.” –Jehoshua Eliashberg
Hovencamp noted that what Disney is attempting here is a “partial asset acquisition,” where Fox retains its national sports channel. “There will be some Fox left after this merger, and those kinds of mergers are usually easier to fix.” In such merger proposals, the government could tell Fox not to sell specific assets, he added.
Disney could also face questions as it gains a greater stake in Hulu. “What kind of fights will that cause in Hulu? What will that mean for the content that’s made available to Hulu or favored by Hulu?” asked Gordon. Meanwhile, Netflix is competing with Disney and Fox in content production, and has said it would spend $8 billion in 2018 for content. “Netflix’s future probably depends less on content from Disney and more on originally produced content.”
Hovencamp didn’t see the content aggregation of the Disney-Fox merger as being problematic because neither one is a bottleneck, unlike the AT&T-Time Warner deal. “They are highly differentiated products. But it’s not like [being] an internet service provider as in the AT&T case, where you’ve got DirecTV plus AT&T’s cable networks — there we get a lot more worried about exclusion.” For example, AT&T could use its distribution power to block DirecTV rivals.
But there is a danger that “due to an absence of cross licensing, these streamers don’t have access to all of the programming,” forcing consumers to subscribe multiple services, Hovencamp said. However, he noted that many consumers already subscribe to more than one online video service.
Outlook for the Deal
All said, Bhargava didn’t expect regulators to see the Disney-Fox deal as posing a significant threat to competition. “I’m a little pessimistic about how successful Disney or Disney-Fox will be in its competition with Netflix,” he said. He predicted that Disney would face “enormous competition not just from Netflix, but also from the other firms that are pushing different types of streaming services.” Among those that are offering online video services are HBO, CBS Sports, CBS News, Sony and Hulu, he pointed out.
“Power is still power, and you find it used in odd and usually anti-competitive ways because no company really wants to be in a competitive market.” –Erik Gordon
Bhargava also saw competition coming from companies like Twitter and Facebook, which are striking deals to acquire live sports and other types of programming. “That is where the eyeballs are now,” he said. “They’re not in front of the TV; they are in front of your Facebook page.”
The Net Neutrality Factor
Hovencamp said the removal of net neutrality will influence how the government views the AT&T-Time Warner deal. “One of the things we did not have to worry about was that the owner of an ISP could actually start excluding or discriminating against programming that’s not vertically integrated like Netflix or Hulu. That’s no longer the case,” he explained. “In a merger where the effect may be substantially to lessen competition, you have to look at that in an environment in which discrimination and refusal to deal is a legal possibility. The trade-off to removal of net neutrality is going to be increased scrutiny of these types of mergers.”
“Disney’s business model … is about getting people to recognize it … and then selling them toys, clothing, theme parks, amusement.” –Hemant Bhargava
With net neutrality protection gone, it makes all the more sense for Disney to become a bigger content powerhouse, said Gordon. “The more content you have, the more negotiating leverage you have in a world where you’re fighting with cable operators or ISPs who no longer have to offer you neutrality but can ask you to pay.”
At the same time, “the more content you have, the more costly it’s going to be for an ISP to exclude you,” said Hovencamp. “You’ve got to rely to a certain extent on market forces here rather than the law. Comcast may have the legal power to exclude Netflix. [But] if they were to do so, the consumer reaction would be so overwhelming that they would just never consider doing anything like that. The bigger the streaming services like Netflix — and now Hulu — will become, the more costly the decision to exclude them will be.”
Bhargava said he did not think content would necessarily be excluded. Instead, “it’s going to be about how they might provide preferential treatment and help consumers discover certain types of content over others, or maybe if you’re a consumer, you observe that certain types of content are more reliable in transmission and display than others,” he said.
The power that Disney would get with the Fox assets also goes beyond making money from content, Bhargava said. “Disney’s business model … is about getting people to recognize [its brand] and then selling them toys, clothing, [tickets to] theme parks,” he noted. “As long as Disney is able to capture consumers through streaming but not necessarily make a lot of money, that’s okay because they can then monetize those consumers and the brand in other ways.”
