Is AT&T DirecTV Acqusition a Big Mistake, a Clear Win, or a Deal of Unknown Ultimate Impact?

Some critics believe AT&T should not attempt to buy DirecTV. Some might say the deal was a reaction to the Comcast proposed acquisition of Time Warner Cable and will not provide enough synergies to drive value. In that view, AT&T should spend its acquisition or network capital elsewhere.

Some question the amount of potential acquisition savings AT&T has claimed. But that might not even be significant. The issue is that AT&T might wind up in a situation where it has to pay out 70 percent to 80 percent of its cash flow to cover its dividends.

For that reason, some think AT&T simply shouldn’t do the deal. So far, there is no evidence AT&T will withdraw. In fact, AT&T already seems to have reached agreement with regulators about what AT&T has to do to gain antitrust clearance.

Those who oppose the deal are left with the hope regulators will block the deal, but that seems unlikely, in view of the news that antitrust concerns have been dealt with.

But what if “synergies” are not the issue, or even video scale? What if AT&T actually believes DirecTV offers a high cash flow opportunity, even if it might be a slowly declining business, and that the cash flow is reason enough to do the deal?

AT&T would not be the first company to find it must finance both high investments in its core business, as well as pay significant dividends.

In that view, whatever AT&T might do, access to high cash flow from DirecTV helps by supplying cash for dividend payments, while the company continues to invest in its gigabit networks and other new lines of business.

To be sure, some will make the argument that AT&T essentially is not telling the truth; that it will eventually do something other than what it now says it will do.

An independent DirecTV might actually already believe it has passed the highpoint of its subscriber adoption, if it remains an independent company.

But AT&T might argue it has a solution for that problem, namely the ability to bundle DirecTV with mobile service, fixed Internet access and voice. In that scenario, might DirecTV’s eventual decline is much more gradual?

It’s a reasonable theory, if still a theory. Keep in mind that virtually everybody believes linear video, as an industry, already has passed its peak. What forecaster, inside the companies or outside them, really believes the market can grow from here?

Rather, the strategic challenge is to prolong product demand as long as possible, as profitably as possible.

AT&T and DirecTV might believe bundling opportunities will play a big role in that regard.

Some argue there are synergies.  Certainly AT&T has suggested it will benefit to some extent by becoming a more-sizable buyer of content for its linear video services, on the strength of DirecTV’s mass.

But much will hinge on what conditions the Federal Communications Commission or Department of Justice might attach--and to which AT&T already has agreed--in exchange for approving the merger.

If past precedents provide guidance, that will mean a period of perhaps three years when existing packages and prices for current customers are protected from change.

In a drastic scenario AT&T obviously does not expect, AT&T might be required to divest video subscribers in any areas where its U-verse services are offered. That seems an unlikely FCC or DoJ objection, but it is possible.

Still, it seems unlikely AT&T would be willing to buy DirecTV for its stated price if AT&T believed the value of DirecTV would be reduced by as much as 5.7 million video accounts that would have to be divested.

About as thorny an issue as that is which network would support the divested customers. AT&T, it seems likely, would not want to support a new third-party owner of divested U-verse video accounts, running over AT&T plant. Nor would AT&T seemingly gain so much contract scale were it to have to divest its 5.7 million U-verse video accounts.

It therefore is hard to believe significant divestitures are contemplated.

Assuming few if any accounts actually must be divested, there is the matter of potential synergies. AT&T might, some think, simply continue to operate U-verse video on the fixed network and DirecTV as separate businesses.

There are no network synergies there. And some might argue there could be additional costs, particularly if AT&T has to do something major with the DirecTV or U-verse decoders to harmonize features and user experience.

DirecTV decoders might ultimately be outfitted with Long Term Evolution capability for return path signaling, for example. Depending on the number of box swaps, that could represent a rather large capital outlay, at $400 per customer, on average. Or pick some other number, if you like.
The point is that synergies might be few. And AT&T might still want to do the deal.

Any bundled offers would necessarily be a billing and marketing issue, with actual service provided by as many as three separate networks--satellite, fixed and mobile networks.

It might not be as elegant as a single fiber-to-home platform, but it can work. Service providers already do such things.

Still, there are other currently-imponderable longer term decisions. Perhaps half of AT&T high speed access customers bundle video with broadband access.

In the first quarter of 2014 AT&T had 11.3 million U-verse broadband customers and 5.7 million U-verse TV subscribers.

Compare that to Verizon Communications, which sells a FiOS video unit to about 80 percent of customers who buy FiOS broadband.

Verizon had 6.17 million FiOS broadband customers as of March 31, 2014, plus 5.32 million pay-TV subscribers.

If regulators approve the DirecTV purchase, AT&T says that it will still offer U-verse-branded TV to consumers in areas where its network has been upgraded to enable the service.

What happens in the future is probably the bigger issue. "Longer term, I think they will look to sell a bundle of satellite and U-verse data: it's more efficient and a better service," argues  UBS analyst John Hodulik.

Whether that is “better” is a judgment call. But that approach could have implications. Some might argue AT&T will simply slow down its bandwidth upgrades. If it does not have to support video services over its fixed network, virtually all the physical bandwidth could be devoted to Internet access.

Cable companies face the same issue: they have to apportion bandwidth to support both video and Internet access. One of the advantages of switching to all-digital video delivery is that it is more efficient, in terms of bandwidth consumption, and essentially allows cable operators to use more of the network to support high speed access.

At some point, more than three years out, one could conceive of a move by AT&T to stop delivering video over its U-verse network. That would be disruptive, and could lead customers to churn off U-verse in substantial numbers, so one would think that is an unlikely plan.

U-verse video, assuming an average $80 per unit, represents $960 a year of gross revenue. At At 5.7 million units, that is $5.47 billion a year in annual revenue.

Of course, one can imagine other scenarios. AT&T could try and induce customers who buy U-verse video to buy DirecTV instead, reducing its exposure to the loss of U-verse customers, were it ever to decide U-verse video was not warranted.

That migration strategy would reduce exposure, if AT&T did decide to abandon U-verse video at some point. A couple of scenarios could drive that decision.

Linear video subscriptions could take a suddenly sharper downward path industry wide, shrinking the total linear video market.

Or AT&T might someday conclude that the profit margin on high speed access is so much higher than linear video that the business case for devoting nearly all bandwidth to high speed access becomes more compelling.

It is less crazy than it sounds. Cable operators already can model a future business where demand for linear video is much lower, and demand for high speed access is much higher.

Verizon Communications executives say in public that the profit margin on FiOS video really isn’t that great.

There are probably more scenarios than we can even imagine right now.
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