Sunday, May 18, 2014

AT&T DirecTV Buy is Not Perfect, Just Best Available Move

None of the largest U.S. telecommunications providers have “perfect choices” where it comes to growth strategy. Comcast, AT&T and Verizon are big enough that market share issues alone will continue to raise antitrust issues in the internal U.S. market.

CenturyLink has room to grow, but as a fixed network services provider, faces the issue of inability to enter the mobile business. At this point, it has neither the capital to buy its way in, nor the platform to grow a business organically.

Historically a rural fixed line provider, CenturyLink now is a hybrid, operating some larger metro networks as well as in “traditional” smaller markets.

CenturyLink could grow by eventually acquiring rural assets AT&T or Verizon might like to divest. That is a tack Frontier Communications has taken, for example.

But both Windstream and Frontier, traditionally providers of smaller market fixed network services, have gotten their recent revenue growth from business services, not consumer services.

Dish Network has particularly been concerned about the viability of any stand-alone satellite video business in an era of triple-play and soon quadruple-play services in the consumer markets.

Though a combination of Dish Network and DirecTV might have made lots of near term sense, that deal would not solve the problem the satellite providers face as there is a strategic shift in the consumer market to quad-play services.

And such an option obviously is foreclosed if AT&T buys DirecTV. One way or the other, Dish now seems committed to becoming a provider of triple-play or quadruple-play services.

Despite the business model difficulties, one might argue that is precisely the context that has shaped small and independent fixed network telco strategic choices as well.

As always, the price at which any significant new assets are obtained could make a difference, but in the absence of “distress” sales, though additional scale helps, there are issues about the amount of leverage would-be acquirers must face.

In AT&T’s case, some observers worry that an acquisition of DirecTV means debt burdens would grow, as well as decreasing the amount of cash flow available to fund network upgrades and further growth. AT&T will have to address those concerns operationally.

And all of the larger firms face antitrust and competition concerns.

Comcast diversified significantly by buying NBC Universal, but also has offered to sell off perhaps three million video accounts as a concession to win Time Warner Cable, that move an effort to say below 30 percent share of the U.S. video market, even as it would vault Comcast into a clear lead in high speed access share, with perhaps 40 percent share of that market.

Sprint faces similar issues as it considers an acquisition of T-Mobile US.  Antitrust authorities and regulators consider the mobile market already too concentrated. The issue there is whether Sprint can convince authorities that long-term competition, innovation and investment, as well as consumer welfare, are better served by three strong providers.

As in France, that now is precisely the conclusion national regulators have reached. Though four strong providers are preferable, French telecom regulators now believe levels of competition in mobile services have reached ruinous levels.

At least in part, French regulators believe consumer welfare, in the form of lower prices, as well as investment, are best served by three stronger providers, rather than four weaker providers.

So in addition to regulatory issues, leverage and even dividend policy are key concerns for any large deals. Taking on large amounts of debt to fund acquisitions is out of the question for most of the largest service providers. But for AT&T, issuing new equity also increases the dividends it must pay.

There also is an issue of “where” growth by acquisition is most strategic. Some observers think AT&T does not benefit as much from owning DirecTV, compared to other uses of capital.

Beyond the concern that the linear video business is mature, with growth decelerating, there is the larger strategic concern of the shift to online delivery that imperils the whole linear video business.

For the larger rural providers, the issue is the wisdom of becoming bigger suppliers in a market whose growth prospects are negative, and where recent success has been gotten in business services, not consumer services.

For fixed network providers, where participation in the mobile segment might be helpful, it now is mostly too late to enter the market, with needed scale. Basically, the mobile business has become a “national” business, with little if any room for small or regional providers, long term.

Even if AT&T wants to grow its mobile share, regulators have closed that route. Whether AT&T can afford, or wants to add significant new fixed network assets, likewise is questionable, even assuming regulators would approve, and that seems equally unlikely.

Inability to grow domestically is one reason why AT&T had been looking to buy international assets, recently. In fact, buying a specialized video provider is one of the few domestic options AT&T actually can exercise.
AT&T faces all those issues, ranging from regulatory barriers to revenue growth to capital constraints.

In proposing the acquisition of DirecTV, AT&T undoubtedly will tout the incremental boost to free cash flow, a fundamental change in profile in the video services segment, ability to better manage large dividend payments as well as fund fixed network high speed access investments.

AT&T might also suggest there are advantages in negotiating programming contracts that could be worth $400 million annually. AT&T possibly will hint at ways to use DirecTV to offload video traffic as well, allowing nearly all of its fixed network bandwidth to support high speed access.

But none of the choices are “perfect” at this point, for any of the larger service providers. If it cannot grow internationally at the moment, and if its key U.S. competitors are making moves to gain share or change the strategic context, a DirecTV might be the best immediate move.

Keep in mind the fundamental growth context for cable and telco service providers over the past decade. Telcos have gained video share, while cable has gained voice share, as well as dominance in high speed access.

But there are strategic changes as well. As Google Fiber has shown, the foundation for fixed services revenue now is high speed access, packaged in a disruptive way, complemented by video entertainment, with new cost parameters.

Though “video” has been the big business model challenge for telcos, high speed access now has become more crucial as well, first to catch up with cable, and now to fend off challengers providing gigabit levels of service at vastly destabilizing price points.

AT&T is likely to argue, in essence, that buying DirecTV helps it solve both problems. At least in principle, buying DirecTV helps AT&T fund its fixed network high speed access investments while gaining an important new position in video, the key strategic complement to high speed access.

It perhaps is not a “perfect” move. But it just might be the best available move.

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