AT&T has hit a roadblock in its merger with Time Warner Inc. in the form of a law suit from the Justice Department to prevent the deal. This may offer an opportunity for investors to benefit.
Special Mandatory Redemption Provisions
When undertaking a large acquisition, bonds can be issued to pre-fund the deal before the final legal closure occurs. Often this requires shareholder or regulatory approval and there may be doubts over whether the deal will actually be consummated. For some of this pre-finance, they may include SMR language – Special Mandatory Redemptions. Essentially if the deal fails to materialise (usually by a back-stop date) then the bonds are redeemed at 101 (plus accrued interest to that date).
This can be both a positive and a negative for holders of the bonds. If the price has moved above 101, then there can be a painful loss of value. However, with a bond price below 101, there is scope for some capital appreciation. With yields rising, however, a number of bonds with this language sit with prices below 101. This gives the potential for a capital gain if the acquisition process fails.
AT&T, the US telephony company, is in the process of acquiring Time Warner Inc., owner of a number of media brands and assets such as CNN, Warner Bros. films, HBO and Turner Sports. This would fit well with AT&T’s purchase of satellite broadcaster DirecTV and diversify revenues from its reliance on telephony.
At the end of July, AT&T issued $22.5 billion — ranking as the third-largest corporate bond sale on record. Issuance consisted of seven series, all subject to a special mandatory redemption at “101 percent of the principal amount of the notes plus accrued but unpaid interest if the merger agreement with Time Warner is terminated or the acquisition of Time Warner does not close by April 22, 2018”. It also issued two euro tranches and a sterling bond in June with the same clause.
The market was expecting the deal to close this quarter well before the back-stop date but, as they say in America, in “a left-field move” the Justice Department (taking a leaf out of the Warner film franchise “Justice League”, possibly) has instigated a lawsuit to block the merger. The Justice Department’s argument is that the deal is anti-competitive and therefore unlawful. AT&T is seeking to argue against this but there is a political element hanging over the deal as President Trump has in the past said the merger should be blocked and dislikes CNN.
A deal could be struck, like the one for Comcast when it merged with NBC in 2011, which imposes conditions on AT&T to improve its “behaviour” post a merger. However, the Judge appointed, Richard J. Leon is viewed as conservative and unlikely to move for a settlement, and looks to be sceptical of behavioural remedies given his negative views on the Comcast/NBC consent decree.
The clock is now ticking and AT&T has four months to close the deal. It could seek to extend the deadline with bondholders but it may need to offer an incentive to do so. Currently all the dollar bonds are trading below 101 in price and therefore offer some upside to investors. The euro issuance is above 101 and therefore could see a price drop. In the sterling market, the 2037 bond also sits below par, offering the chance for a capital gain.
Note: Since we published this article, the court date has been set later than AT&T and Time Warner had hoped. It is now set for March and it looks like the SMR provisions are likely to be triggered. AT&T have a few months to decide and it is possible they will seek to extend the deadline for the provisions. This would require a ‘consent solicitation’, which usually involves them paying a fee to bondholders or they could redeem and re-issue the bonds. Either way, bondholders should benefit.