How Will Verizon and AT&T Stave Off Attacks from the Rest of the Ecosystem?

Reasonable people can, and do, disagree about the wisdom of AT&T’s acquisitions of DirecTV and Time Warner. In fact, it is likely easier to find opponents than supporters of each move.

Many argue AT&T should be more like Verizon, and stick to mobile, or connectivity services. That’s a reasonable argument, but some would argue Verizon has different legacy assets, and therefore can pursue different revenue strategies than AT&T.

For starters, the fixed network no longer drives growth for anybody.

Verizon simply cannot grow very much in its fixed network business, so one might argue the emphasis on mobile makes sense. On the other hand, Verizon cannot grow that much in mobility, either, given market maturity.

AT&T also cannot grow very much in mobility, competing against Verizon as the leader, and T-Mobile and Sprint as the challengers.

Both Verizon and AT&T must find revenue growth, though, to fund their dividend payments. And that is where the issue of strategy becomes so perplexing. Verizon has managed its debt better than AT&T by restricting its ambitions.

AT&T has chosen to grow into new parts of the ecosystem, at the cost of high debt positions.

In the near term, financial analysts tend to prefer Verizon’s approach, and many think AT&T should retrench.

Being someone who believes the long-term trends are for connectivity prices to continue to dip towards zero, and with competition impinging on legacy revenue models, I do not believe a “stick to your connectivity knitting” approach is workable, long term.

Organic growth will be extremely difficult to maintain, and that, to me, means acquisitions will be necessary. The issue is what sorts of acquisitions are possible.

For a substantial amount of time, both AT&T and Verizon got a majority of their growth from acquisitions. In fact, the additional scale also played a meaningful part in organic growth.

Recently, Verizon has tried to grow organically, while AT&T has made acquisitions to reshape the company’s revenue streams outside connectivity.

source: Deloitte

Many do not like AT&T’s moves.

But we might ask a simple long term question: how is it safe for “connectivity services” providers to entrench in that sole role when the whole rest of the ecosystem is moving across it? It is not easy. It will be dangerous. But what is more dangerous than staying in one silo whose revenue is not growing, when profit margins continuously drop, and when competitors from other parts of the ecosystem are moving to displace the pure connectivity role.

source: Jackdaw Research

Among the other issues is the declining financial return from each next-generation mobile platform, at least in terms of the number of years of useful life obtained from each platform. Simply, return on assets has been falling, in part because each network has a shorter useful life.

source: Innosight

And if we know anything about the modern telecom business, it is that organic growth, while still important, does not tend, over time, to drive total revenue growth. To me, that means acquisitions are necessary.

source: JackDaw Research

We may disagree about which acquisitions make sense (horizontal, vertical, internationally or domestic). It seems much less contentious to argue that future acquisitions will be necessary.

As far as the wisdon of the DirecTV and Time Warner acquisitions, I have yet to see any clear evidence--from those who think AT&T should not have made one or both of those buys--that some other deployment of capital, or not spending, for that matter, would have had a better outcome for AT&T in the revenue and free cash flow areas, near term.

Hulu and YouTube TV Might be Among Biggest Streaming Winners

Hulu and YouTube are among the bigger winners in streaming video by 2022, Business Insider predicts. Sling TV and Playstation Vue are among the big losers. We might note that both Hulu and YouTube TV are anchored by their “live TV” (linear)  content.

We sometimes forget that the legacy subscription TV business (cable, telco, satellite TV) is itself an amalgam of “live” and “pre-recorded” content. The paramount examples of “live” content being “sports and news;” the best example of pre-recorded content being movie services.

In the streaming era we will see lots of niches recreated out of legacy content formats, including services that emphasize pre-recorded content; some that emphasize “live content” (sports networks, news) and many that recreate in a streaming format today’s mix of channels.

The “live streaming” segment of the market will include the specialized sports and news venues, plus what we tend to call “skinny bundles” of channels that resemble subscription TV but offer fewer channels.

Some services, including Netflix, might continue to thrive using the pre-recorded content model. Sling TV might be the original skinny bundle supplier. But there is lots of new competition coming in that segment from Hulu, DirecTV Now, YouTube TV and others.

source: Business Insider

Where Will Highest Revenue Growth Happen in Telecom, Through 2023?

With the caveat that aggregate global trends can conceal local differences, the highest-growth products in the communications business through 2023 are streaming video, mobile internet and video games. Traditional subscription television growth will be zero, while fixed broadband will grow at two-percent compound annual rates.

source: PwC

What Happens Next in Telecom Industry?

Looking at market share held by the largest three companies in the industry, one can clearly see that industry consolidation rises over time. The existential danger is the bend of the S curve late in the cycle, which shows loss of market share to new competitors or products.

For telecom service providers, the danger is that late-cycle shrinking of the core market.

Eventually, the S-curve suggests, entire markets become unstable, and can shrink, because of changes in technology, customer demand and business model evolution, almost always from outside the traditional boundaries of the industry.

source: AT Kearney

We already have seen this for key segments of the telecom industry, where long distance revenues changed from high margin, high volume to low margin, low volume. We have seen the shrinkage of fixed network voice lines in many developed markets, lower profit margins and revenue from mobile voice and messaging.

At the same time, mobility has assumed the role of driver of industry results globally, while internet access and video services have replaced some of the losses from voice services.

That sort of product replacement is normal.

The big industry question is what replaces mobility as the industry driver, as mobility growth reaches saturation.

Between 2009 and 2019, Internet Access PPI Prices Fell, CPI was Flat

This chart shows the producer price index for U.S. internet access services between 2009 and 2019. The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling prices received by domestic producers of goods and services, according to the U.S. Bureau of Labor Statistics.

The Consumer Price Index measures price change from the purchaser's perspective. Sellers' and purchasers' prices may differ due to government subsidies, sales and excise taxes, and distribution costs.

source: Bureau of Labor Statistics

The importance of the PPI data is that the “cost” of internet access has fallen over the 2009 to 2019 period, before service provider non-controllable costs such as taxes are added.

The importance of the PPI data is that the “cost” of internet access has fallen over the 2009 to 2019 period, before service provider non-controllable costs such as taxes are added. The same time period, looked at from the Consumer Price Index, shows what end users pay, including taxes that are part of the cost of the product.

source: BLS

Including taxes, the cost of internet access between 2009 and 2019 has remained flat.

Can, Should AT&T Divest DirecTV?

By some estimates, AT&T free cash flow overall is about 14 cents for every dollar of revenue, while Verizon earns 16 cents per dollar of revenue. So some worry about the cash flow generating capability of AT&T’s DirecTV business, which most reasonably expect to drop over time.

Some even speculate that AT&T would be better off selling DirecTV.

That might not be an easy decision. DirecTV still represents per quarter, or roughly $32 billion worth of annual revenue and probably $2 billion per quarter of free cash flow, $8 billion annually. For a firm whose financial model is based on high dividend payments, free cash flow to pay those dividends really does matter.

source: Business Insider

source: Bloomberg

Beyond all that, does it really make sense that AT&T, whose new positioning is a “modern media company, really want to chop media revenue and cash flow to reduce debt, as important as that is? Does AT&T really want to lose the bundling and churn-reduction advantages it seemingly reaps from offering video plus internet plus mobility?

Even if Time Warner arguably represents the future of AT&T’s video streaming efforts, there is no way revenues and cash flow from streaming can replace the linear video business anytime soon.

Some believe AT&T should have spent its cash on something else, such as more fiber-to-home deployments, for example. Few believe there was any way for AT&T to expand by growing its mobile or fixed network assets inside the United States.

But for some of us, that is the primary issue: can AT&T wring much more revenue out of its fixed and mobile footprint? An argument can be made that more FTTH investments would not provide the revenue or cash flow lift of acquisitions such as DirecTV or Time Warner. In fact, some would argue higher returns, and better strategic value, is possible only elsewhere in the ecosystem.

We can argue about the merits of the DirecTV and Time Warner acquisitions, compared to other possible uses of cash. But it is hard to see where else AT&T could have gotten free cash flow and revenue gains, immediately, from other investments such as more fiber-to-home or advanced LTE.

Sure, AT&T could divest DirecTV. It could use the proceeds to reduce debt. But where else can AT&T quickly boost revenue and free cash flow, were it to do so? I just do not see it.

AT&T FTTH Gains Seem Mostly Upgrades by Existing Customers

What impact is AT&T fiber-to-home having on company internet access accounts. Well, it is, as they say, “complicated.” For two decades or more, when a telco replaces copper access lines with optical fiber, it sees two types of changes.

Copper-based accounts go down, while optical accounts go up. Perhaps most of the change is simply existing customers switching from copper to fiber access services, for little net gain in total accounts.

That seems to be happening with AT&T FTTH accounts as well. According to Moffett Nathanson, AT&T achieved 57 percent growth rates for its FTTH services over the past year. But total broadband accounts have not grown at the same rate.

“Despite the dramatic growth at AT&T Fiber, AT&T’s broader IP broadband category has posted only modest subscriber gains over the past year,” the firm says.

The logical explanation is that existing customers have been upgrading to the new FTTH service, and dropping their former copper or fiber-to-node service. That also would make sense if AT&T conducted the sort of marketing campaigns cable operators do when introducing a new service: target existing customers first.

Over time, as those conversions reach an end, AT&T is likely to switch to targeting non-subscribers. Only after a few years of that activity will we be able to assess how well AT&T’s FTTH program has been in potentially taking market share from cable operators.