Quick Thoughts: AT&T makes its TV move

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–          T’s DTV deal is old paradigm thinking in the long term, but adds near term upselling opportunities for existing subs, leverage w/ content nets, and an intriguing LatAm play.

–          “Triple Play” may be played out – the DTV US business could be a long term liability as TV watching inevitably wanes. The deal includes a wise out for T if NFL Sunday Ticket falls through.

–          DTV has licenses for fixed wireless broadband to 43M households in Argentina, Brazil, Colombia, and Peru – opening ex-US markets to T for growth

–          Both CMCSA/TWC and T/DTV face tough FCC and DOJ review, which could block them or force major concessions. Higher concentration in US TV would be unequivocally bad for networks.

AT&T’s bankers were busy this weekend hammering out details of a $48.5B deal to buy DirecTV to turn the once smallest Baby Bell into a pay TV juggernaut. The deal is not surprising on the heels of Comcast’s $45B bid for Time Warner Cable’s 14.5M subs three months ago. With no broadband product to compete head to head with the proposed mega cable behemoth, DirecTV’s board weighed its options and, after years of flirting with AT&T, chose to sell itself. While the deal makes sense for DirecTV, the value for AT&T is not clear. DTV doesn’t add any new spectrum assets aside from fixed wireless broadband licenses in Argentina, Brazil, Colombia, and Peru covering 43M households, and has no technology to aid AT&T in its pursuit of US internet customers. Though the deal will add 20.3M DTV subs to T’s weak sister 5M sub Pay TV operation, multichannel is a low growth business threatened by new over the top services including the likes of Netflix, Hulu, Amazon, and Aereo in certain markets. DTV adds some 18.1M subs in Latin America, where growth potential is high, but high churn, high customer acquisition costs, and idiosyncratic country risks could be a pitfall.

AT&T and DirecTV have been cordial since 2010, when they first tried to strike a deal. Both have approached the changing TV landscape differently. AT&T has been slowly building out its mostly fiber to the node network since 2006, and committed $6B in CAPEX to continue building out the service between 2013 and 2015. It also shuffled around its business when it sold its Connecticut assets to Frontier for $2B late last year, which included 180K U-Verse video subs, to raise money for more network improvements rather than tapping into dividends coveted by value investors. DirecTV on the other hand has been buying back stock without reinvesting much into the business. It spent some $29B on share buybacks in the last eight years. While it tested offering fixed wireless broadband with Verizon, it abandoned the efforts and instead focused on growing its Latin American operations.

After learning a hard lesson from the failed takeover of T-Mobile in 2011 where AT&T paid out over $4B in a merger breakup fee, AT&T CEO Randall Stephenson was careful to avoid a hefty termination payout in his latest deal. As it stands, the merger agreement protects AT&T from several risks and gives it the right to terminate the merger with no penalty if DTV fails to extend rights for NFL Sunday Ticket programming. It also would give AT&T a $1.45B payout if another bidder were to swoop in and offer a higher bid. Still, the deal is more complicated than CMCSA/TWC with a dependency on foreign approvals from Latin American authorities including Mexico where T has a stake in Carlos Slim’s America Movil. T has been shedding its America Movil stake since last year and will look to liquidate its entire holding to gain regulatory approvals. Domestic approvals though will still be a challenge given that the same cast of characters lobbying against CMCSA/TWC will also go after this deal including consumer groups and smaller cable systems. Senator Al Franken who bashed Comcast in a Senate Judiciary hearing last month, was quick to speak out against T/DTV right after it was announced. Then again, Comcast and AT&T are hoping both deals moving through the approval process concurrently could be parlayed into an outcome favoring industry consolidation.

If both deals were to go through, both T and CMCSA would have more than 30M US subs apiece, collectively controlling more than 60% of the Pay TV market. That industry consolidation would be unequivocally bad news for the TV networks, who would lose power in negotiations for retransmission fees, and for consumers who could see higher prices in the process and less investment in support of internet TV. Approval of both of these deals could also set precedent for the approval of a rumored Sprint/T-Mobile tie up that would reduce the number of scale wireless players in the US to three, another potential blow to consumer wallets and to industry innovation. The biggest loser in this scenario could be Dish, which could find itself without a partner at the end of the dance. Charlie Ergen’s next move may be a doozie.

For our full research notes, please visit our published research site.

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