Thursday, May 15, 2014

AT&T Bid for DirecTV Really Isn't Puzzling

AT&T’s potential deal to acquire DirecTV will strike many as puzzling, given the deal’s inability to directly affect either AT&T’s mobile business, its international profile or fixed network business.

To some extent, the potential bid has been triggered by the Comcast bid to buy Time Warner Cable, a deal that would vault Comcast clearly into leadership of the U.S. high speed access business, though keeping its overall video subscriber market share below a 30-percent level that draws regulatory scrutiny.

When a key competitor in a supplier’s core market makes a move that promises to make it stronger and bigger, rivals typically have to respond.

To be sure, AT&T might well have preferred an opportunity to expand internationally. But deals large enough to make a difference, available at reasonable cost and relatively likely to win regulatory approval arguably did not exist.

source: National Broadband Plan
And a new threat in its core market likely also affected strategic thinking. As difficult as “broadband” and “video” have been for U.S. telcos, in terms of capital investment intensity and financial return, it now is clear that the future of fixed networks is bound with high speed access and video entertainment.

And in that sense, AT&T has to take seriously a jump in market share for high speed access, by Comcast, to 40 percent of the U.S. market, making Comcast the undisputed market leader.

That has strategic implications for all other major competing service providers.

To the extent that fixed networks have a clear value and rationale, it is as suppliers of the highest-bandwidth platform, delivering connectivity at the lowest cost of any platform, on a cost-per-bit basis.

Source: UBS
In that regard, it is high speed access itself which becomes the foundation service, but video entertainment has emerged as the lead application for such a network, beyond Internet access.

Perhaps not far behind is the value of the fixed network as a means for offloading traffic from a mobile network, the most-important indirect driver of value for the fixed network.

So it is not so much Comcast’s gain in video subscriber share that are most important, from AT&T’s perspective. It is the immediate market share lead in high speed access which is most important.

What is very clear is that, with a few exceptions (Verizon FiOS and Google Fiber, plus a few independent ISPs), cable-provided high speed access operates faster than telco high speed access. Cable TV suppliers also are winning the battle in terms of net new high speed additions as well.

Some might argue that acquiring DirecTV does very little to help AT&T extend its potential high speed access footprint. That is true.

But there are other important elements. DirecTV would supply high-margin revenue and cash flow that AT&T can use to upgrade its fixed networks for faster speeds and video services.

And there are few acquisitions AT&T actually can make in the U.S. market in its core triple play and quadruple play markets. Regulators already rejected AT&T’s effort to buy T-Mobile US, as that was deemed to reduce mobile competition too much.

And AT&T has, since 2006, not been in the market to expand its overall fixed network footprint for several reasons. Higher returns from mobile services are a primary reason. But market share issues exist.

AT&T’s fixed network market share (looking only at the telephone industry), measuring either by subscribers or revenue, is the highest of any telco, reaching more than 40 percent share of voice or high speed access connections.

AT&T’s fixed network passes about 50 million U.S. homes, or about 42 percent of total U.S. homes.

AT&T holds about 47 percent of “telco” high speed market share, for example, though only about 20 percent of total U.S. ISP high speed access accounts.

The point is that, within the U.S. telephone industry, AT&T already arguably has reached a size where any further acquisitions would be challenged on competitive grounds.
The upshot is that AT&T cannot easily make domestic acquisitions in the fixed network or mobile realms. Buying DirecTV, though, changes only AT&T’s small video service market share.

In 2013, for example, AT&T had only about six percent share of the linear video subscription business. DirecTV had about 21 percent share. So a combined entity would have only about 27 percent market share.

The point is that AT&T would face far fewer regulatory opposition by making a DirecTV acquisition, and almost no chance of approval were AT&T to propose buying additional mobile or fixed network market share.

The other issue is that AT&T (originally SBC) has grown primarily through acquisition, not organic growth.

AT&T bought Pacific Telesis for $16.6 billion in 1997, Ameritech for $73.2 billion in 1999, AT&T for $16.1 billion in 2005 and BellSouth for $85.2 billion in 2006. Those deals primarily gres its fixed network business.

AT&T Mobility similarly was built on acquisitions. In 2000 BellSouth Mobility and SBC merged to form Cingular. In 2004 AT&T Wireless was bought. IN 2006 AT&T Mobility acquired the former BellSouth interest in Cingular.

AT&T Mobility also acquired Dobson in 2008 and and Centennial in 2009, as well as Leap in 2014, with the failed bid for T-Mobile US in 2011.

A DirecTV acquisition is one of the few deals of any magnitude that AT&T can make, with hopes of winning approval.

The bid might seem puzzling. It really isn’t.

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