24/06/22, Discovery and WarnerMedia
The ultimate tax manouevre.
Hello everybody, hope all is good. No massive updates etc, so let’s dive in!
Outline
Are you a massive company? Do you want to transfer part of your operations in a way that incurs zero tax?
The answer to both of those questions is almost certainly a resounding no, but in the event that a major executive is perusing this newsletter, then I have just the solution for you: the Reverse Morris trust.
When AT&T (telecoms) sold WarnerMedia to Discovery (media), they did it through a rare and complex legal mechanism, which ensures that no tax was paid.
In this edition, I’ll show you just how crafty companies can get, all in the pursuit of avoiding a bit of tax. Well, billions of tax in this deals case, but you get the point.
Timeline
2018: AT&T (telecoms giant) acquire WarnerMedia for $85b because they want to become a ‘vertically integrated media conglomerate’. Sounds like me on a Friday night.
Early 2021: AT&T CEO John Stankey and Discovery CEO David Zaslav begin negotiations regarding WarnerMedia as they are watching a golf tournament. So much for the conglomerate. The talks were so secret that even WarnerMedia CEO Jason Kilar wasn’t told about them.
May 2021: Bloomberg reports that AT&T wants to sell WarnerMedia.
The next day: Immediately after this report, AT&T announces WarnerMedia will be sold to Discovery. Interestingly, they structure the deal through a Reverse Morris Trust. More on that in the analysis - in short, these guys figure out a way to pay 0 tax on an 11-figure transaction.
April 2022: Merger completes with AT&T receiving $41b, and with AT&T shareholders (not AT&T itself) owning 71% of newly-created WarnerBrothers Discovery. The company aims to accrue $3b in synergies over 2 years, with the long-term goal being a harmonisation of WarnerMedia’s HBO Max streaming platform with Discovery’s Discovery+ platform.
Analysis
Reverse Morris Trust: type of transaction or name of my fantasy football team?
So, the transaction seems pretty plain right? Wrong. Well, I guess it depends on your conception of plainness, but the Reverse Morris Trust is a fascinating legal mechanism that is hardly ever used.
I’ll explain a Reverse Morris Trust through analogy: company A splits part of its operations into a new company, called B. Company C then completes a merger with B, creating new company D. Importantly, shareholders of A must retain majority ownership of D for it to be a Reverse Morris Trust.
In Discovery’s case, that meant AT&T’s shareholders retained 71% ownership of WarnerBros Discovery. If you’re feeling nerdy, the structure of the transaction is graphically demonstrated below:
What’s the benefit?
Tax, plain and simple. By retaining majority ownership of the new company, AT&T can argue there was no actual sale, and thus no capital gains tax to be paid. In the US, capital gains are taxed at 21%. Ouch. So on a transaction of this size, reducing tax liability is a huge incentive.
Why are they so rare?
The logical question, therefore, is why don’t more deals adopt this structure? In the past 25 years, only eight other media deals have used it.
There are two main reasons:
Only created recently: the Reverse Morris Trust structure was created after the US Court of Appeals affirmed it in 1966, with C.I.R v. Morris Trust. Thus, any deal preceding 1966 (in the US) cannot have benefited from this tax efficiency.
Requirements: to qualify for a Reverse Morris Trust, companies must have positive income for 5 continuous years. With our current growth-oriented, profit-ignorant, environment (*cough* bubble *cough*), that automatically excludes a huge number of big companies.
Examples
This structure is particularly popular with asset-heavy companies. They use Reverse Morris Trusts to basically transfer assets to other companies tax-free. Recent examples are Verizon (telecoms) with Fairpoint and Lockheed Martin (aerospace) merging their information systems division with Leidos Holdings (defence).
Key takeaway: if you’re a financially stable company and want to pay less tax, use a Reverse Morris Trust.
Thank you for reading!
A few of you emailed in to say how much you valued the newsletter recently - to each and every one of you, thank you! Here’s to hoping that each new edition is better than the last!
Further readings
Cadwalader, ‘RMTs Roll On: Case Study on AT&T’s RMT Deal With Discovery’
Harvard Law School, ‘M&A Negotiation Tactics: In Discovery-WarnerMedia Deal, AT&T Tries, Tries Again’ (horrendous title with unclear grammar, pretty good article tho)
Investopedia, ‘Reverse Morris Trust’
The Hollywood Reporter, ‘‘Taxes Destroy Value’: Why AT&T Is Using a Reverse Morris Trust in the WarnerMedia-Discovery Deal’
The New York Times, ‘Hollywood Gets a New Giant’
US Court of Appeals, Fourth Circuit, C.I.R v. Morris Trust