Friday, July 13, 2018

What Else Could AT&T Have Done, Instead of Buying Time Warner?

With the caveat that the DirecTV and Time Warner acquisitions by AT&T remain controversial in some quarters, the arguments for both remain simple enough:

  • AT&T’s core businesses are shrinking
  • AT&T has to generate new revenues at scale
  • AT&T needs that revenue to generate high free cash flow, to pay its high and growing dividend
  • AT&T has done so historically mostly by acquisition
  • Beyond which, AT&T has to reposition itself as has Comcast, in additional areas of the internet ecosystem

AT&T needs to generate lots of free cash flow to support its dividend payouts, which historically range between 50 percent and 100 percent of free cash flow. That is hard to do on a declining base of revenues, even if AT&T did not have a strategy of constantly raising its dividend over time.

          AT&T Dividend Payout Ratios (Dividends as a Percent of Free Cash Flow)

Among the primary objections to the DirecTV and Time Warner acquisitions was the amount of debt AT&T would have to take on. This is a valid concern. AT&T has to execute on its plan to significantly reduce debt levels over several years.

Supporters of the DirecTV and Time Warner acquisitions might point out that without big acquisitions, AT&T would have had trouble sustaining free cash flow and its dividend strategy, as organic growth was not high enough to accomplish those tasks.

And it is hard to imagine where else AT&T could have found logical acquisitions that the company could afford, and that fit its core business strategy. Whatever else one might say, media assets have a lower multiple of price to equity than most other assets in the internet app and platform space, in computing or business services.

And a rational observer would likely agree that any big acquisitions must have some reasonable hope of synergy. Consumer video entertainment and video content assets are big enough to “move the needle” for AT&T.

Though we might debate the wisdom of the DirecTV deal, it seems to be working, at least in its role as free cash flow producer. Many have argued that AT&T should instead have made bigger investments in its network. Some of us do not see how that would have generated incremental revenue and free cash flow fast enough to matter.

For AT&T and other developed market tier-one telcos, huge new revenue sources must be found to replace shrinking connectivity revenues.

AT&T’s first quarter revenue revenue trends (legacy business, prior to Time Warner impact) show the basic problem: the core business is declining. That trend compares with a “whole-industry” revenue picture that  is generally flat to just slightly positive.

                           AT&T First Quarter Revenue Trends

You can see the same trend for AT&T free cash flow, in the first quarter of the last three years.

            AT&T Free Cash Flow, First Quarter, Last Three Years

In the end, one must ask what else could AT&T done with its capital to produce an immediate boost to revenue and cash flow, at higher levels or at less cost. Even if AT&T might have preferred investing in internet app provider assets with higher growth, such assets are quite expensive, compared to media assets.

Sure, acquiring assets in the coming internet of things space would be sound, but cannot move the needle on current revenue and free cash flow.

Sure, AT&T might fail to execute well, or might be tripped up by some other exogenous event. But the fundamental thinking is sound enough.

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