AT&T 3Q 2016 Results Illustrate Why Time Warner Ownership Matters

AT&T’s third quarter 2016 financial results might be confirmation that the DirecTV acquisition, heavily criticized in some quarters, is working for AT&T. To wit, AT&T consolidated revenue grew 4.6 percent, year over year, principally because of DirecTV revenues, AT&T said.

More significantly, some might say, the generally flattish growth profile in the quarter shows why AT&T is moving into new lines of business, and how ownership of Time Warner matters.

Net income also grew four percent, year over year.  Operating income grew 8.2 percent, year over year.

Most of the mobile segment account gains of 2.3 million net subscriptions came from connected devices, the Mexico market and Cricket additions.

U.S. mobile postpaid churn was 1.05 percent. AT&T says it gained 700,000 U.S. branded smartphone accounts and 323,000 U.S. DirecTV net adds and 171,000 IP broadband net new accounts.

AT&T also reiterated confidence that it will meet its full-year guidance.

None of that is going to be top of mind, though, as the focus now is on prospects for AT&T’s acquisition of Time Warner. That move sometimes is said to be an effort to lower AT&T’s content acquisition costs, but is incorrect.

Owning Time Warner will not cut the fees AT&T pays to Time Warner for use of its content. AT&T would get price discounts based on volume, as will all other distributors who buy Time Warner content.

During the recent Spectrum Futures conference, mention was made of the fundamental strategy U.S. cable operators will take to “move up the stack (value chain).” Simply, the idea is that “you have to own at least some of the content that flows over your pipe.”

The Time Warner deal appears to be a perfect example of that same strategy, employed by a telco instead of a cable company.

The issue is that all triple-play providers sell a mix of services, ranging from “dumb pipe” Internet access (“tickets to Disneyland”) to applications such as voice, messaging, video entertainment or home security.

But to avoid being reduced simply to a “dumb pipe,” an access provider has to own at least some of the content, some of the apps, some of the services its customers want to use.

In other words, in addition to selling “dumb pipe” Internet access service, which under competitive conditions is subject to price per unit reductions and price competition generally, service providers must become owners of at least some of the new apps and services that its customers want to use.

It is not complicated: that is the strategy for “adding value” and “moving up the stack.” To be sure, there are some tangible benefits. As a major buyer of content from Time Warner, AT&T now at least is able to “pay itself.”

AT&T also now earns more from video than voice services.  

How AT&T benefits from owning Time Warner is a complicated question. Some might think AT&T could win by changing Time Warner content distribution, and making that content exclusive to AT&T.

AT&T will not be able to do so, at least for those networks routinely sold on linear video services.

U.S. rules force content networks that sell content to linear video distributors to sell to all such providers. There is no exclusivity. On the other hand, there are some content services--largely selling only online, that are not covered by the rules.

The interesting example is DirecTV’s NFL Sunday Ticket service, broadcasting football games. NFL Sunday Ticket is not covered by the rules pertaining to programming networks, presumably in large part because the NFL is not directly a programming network, and simply licenses the rights to show games.

Likewise, some new mobile streaming services do not seem to fall under the rules covering linear video programming networks.

At least in principle, some content (programming, rather than networks) could be developed for “direct-to-consumer” delivery, not using the linear video distribution system, and therefore be free of mandatory wholesale rules that pertain to linear video distribution.

But AT&T does not seem to prefer the “unique content” strategy in any case, at least for the moment. That strategy is very expensive, and AT&T seems to prefer the sale of “widely-viewed content” on networks that are themselves widely viewed.

There is some benefit in the area of content acquisition costs, but not direct impact. As programming fees rise, AT&T has to pay more for such content. Owning Time Warner will not change that. But AT&T will gain--as a content owner--from the fees it earns from all other distributors.

But AT&T does seem determined to acquire additional content assets as well, just as it intends to create connected car or eventually other Internet of Things applications and services that also use its network.

What is important, though, is to note that the objective is to “own at least some of the content and applications that flow over the access pipe,” not the desire to create unique walled garden assets available only to AT&T customers. That is a crucial distinction.

The same strategy would seem to apply to other services, in other industries. Connected car services, for example, where AT&T supplies the actual end user service or platform to a car manufacturer, provide one example.

Instead of supplying simple mobile network access, AT&T will seek to become the owner and supplier of connected car services (content, security, vehicle monitoring).

There is a clear strategy here, pioneered by cable TV companies. In a business increasingly anchored by “dumb pipe Internet access,” where there is much competition for any app--voice, messaging, video, utilities, content, transactions--an access provider has to own at least some of the useful apps people want to use.

Exclusivity is not required. Branding is not constrained to the “service provider” brand, in all cases. If people want to use a particular app or service, and that is widely used, it makes sense to retain the retail brands, and not force the use of the access brand.

This is a shift in model. In the past, all services were branded under the parent’s name--AT&T X, Y and Z. In the future, what will matter is the revenue, cash flow and profits generated directly by the end user services and apps, even when--or especially because--those apps and services are in high demand by end users.

In essence, AT&T and Comcast become multi-industry conglomerates, to an extent, making money in several different industries whose common focus is that they require Internet or mobile access.

Moving up the value chain does not always require full branding under the legacy access provider name. It does require ownership of some of the assets.