What's the Rationale for the AT&T Acquisition of Time Warner?

This week AT&T announced the acquisition of Time Warner in an $85 billion cash-and-stock deal.  Investors did not exactly dance in the streets.  Why the concern from investors about this acquisition, and what's the possible rationale for this deal?  The proposed deal is an example of vertical integration, marrying a content creator (Time Warner) with a distribution system (AT&T).   When we hear about vertical integration, we should ask:  Why will these two entities create value by working together, AND why must they merge to achieve this value creation?  In other words, why can they not achieve certain synergistic benefits through other types of organizational arrangements (e.g., contracts, licensing, strategic alliance)?   AT&T CEO Randall Stephenson certainly understands why investors and analysts will ask if a merger was necessary to capture certain benefits of cooperation between the two entities.  Here is an excerpt from yesterday's Wall Street Journal:

AT&T’s Mr. Stephenson said owning content would make it easier for the carrier to adapt to various platforms quickly in a way that is time-consuming and difficult when it has to negotiate contracts with content partners. “It’s slow, it’s painful, just the contracting itself takes a lot of time whereas when it’s completely owned, you just move a lot faster,” he said Monday.

He might be right, but has he captured the whole story?   Stephenson essentially is arguing that the transaction costs of using market mechanisms (such as contracts) to work with content partners are very high.  He believes that the costs of such coordination are lower if the two entities are part of the same corporation.  Simply put, he believes you can accomplish coordination more easily and more quickly through managerial mechanisms than through market mechanisms.   Is that right?  Well, anyone with experience managing a large vertically integrated firm will tell you that coordination between business units owned by the same parent company is not always so easy or fast.  Bureaucracy, transfer pricing disputes, silo rivalry, and other problems can make life pretty difficult. Moreover, vertical integration reduces flexibility at times to work with desirable outside partners or to change business models, and it puts you in the awkward position of competing with your own customers.   The regulatory landscape also complicates the deal.  As the Wall Street Journal explains, "Analysts note that many of the attractive aspects of owning content—such as keeping it out of the hands of other distributors or giving it free distribution—would be barred by regulators."

In addition to examining AT&T's rationale, I've been considering the perspective of Time Warner in this deal. Time Warner CEO Jeff Bewkes has spent the past decade dismantling a prior failed attempt at vertical integration at his firm. He broke apart the AOL-Time Warner combination, and he divested Time Warner's cable operations. Why then sell yourself to a distribution company now? (ok, the hefty takeover premium is the obvious financial reason!). In particular, it seems odd given that Time Warner has begun to sell its premium content directly to consumers, bypassing the traditional cable operators (e.g., HBO Now). I understand that the content creators have been worried about millennials cutting the cord. Witness ESPN's shrinking subscriber base - clearly a concern at Disney these days. Time Warner surely faces such concerns with some of its content, though perhaps not with a premium network such as HBO. I'm not sure, though, that selling to AT&T solves this fundamental problem. Do we think that innovative new entertainment industry business models will emerge from such a large complex entity, or is it more likely to occur from newer, more nimble players in the industry?