Media and Telecom Debt Bomb?

If an anticipated wave of big media and communications mergers happens, a significant number of big firms are going to come under scrutiny for their new debt loads. Right now, AT&T is in the spotlight, but either Disney or Comcast or maybe both will face scrutiny as well, as their debt loads are going to climb, depending on which firm winds up buying the Twenty-First Century Fox assets.

But those moves perhaps illustrate the risks firms in the media and communications industries now might have to undertake in order to reposition for the next phase of industry change.

Adding debt to acquire new assets is a gamble many firms will conclude they must make. For media firms, it now appears that Netflix has changed the game, forcing both a new global distribution focus and a need to shift beyond traditional distribution to streaming alternatives at greater scale.

For tier-one access providers, the issue longer has been the maturation of the access business (fixed and mobile) and the search for alternative revenue sources as voice, messaging and internet access businesses shrink or plateau.

There were many criticisms of the AT&T acquisition of DirecTV at the time. Some believed that AT&T would have been better served investing capital in its fixed network. Others argued that even if AT&T wanted to grow its video subscription business, it would have been better to try and grow organically. Some argued that linear video was a mature business, at best.

Some focused principally on the debt load. Others might have focused on the purchase price, which is related to the issue of debt burden.

AT&T of course had, and has, a strategic rationale. The company has a voracious free cash flow need to support and grow its dividend. The firm arguably also was executing on a plan to move revenue opportunities “up the stack,” into applications. And video entertainment subscriptions are among the few huge and proven consumer apps that are dependent on the networks AT&T operates.

Since then, video has contributed to supporting AT&T’s mobile business, apparently reducing churn and increasing net new subscriptions. In 2017 the entertainment group generated $51 billion of revenue, throwing off $11.6 to $12 billion in revenue every quarter, mostly from video operations.

Those results suggest AT&T could not have grown its video business organically. DirecTV contributes about 82 percent of AT&T video subscription revenue, and AT&T now is the largest U.S. linear video provider, something it almost certainly could not achieved, in the years since the DirecTV acquisition, had it tried to grow organically.

At the end of the fourth quarter, AT&T had about 3.7 million linear video accounts, while DirecTV had 20.3 million accounts. One might well argue it would have been impossible for AT&T to grow its linear business organically, by an order of magnitude, in just a couple of years. Even if AT&T had unlimited capital to invest in its linear video business, it could not have grown that fast.

To be sure, profit margins from the consumer segment are far lower than from business services or consumer mobility, but DirecTV also represents 70 percent or more of consumer fixed network revenue, and perhaps 25 percent of free cash flow (prior to the Time Warner acquisition, which might add another $4 billion of free cash flow and perhaps $31 billion in annual revenue).

Is there risk? Of course. But the traditional media and communications industries are under pressure, and consolidation is among the ways they hope to cope with greater competition and slower growth in the core businesses.
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