AT&T Reaffirms Commitment to Content and Content Distribution

When AT&T outlined its market focus at its recent investor day, three priorities were named: broadband connectivity; software-based entertainment and “fantastic storytelling.” Many opposed the acquisitions of DirecTV and TimeWarner, preferring that AT&T remain focused on its connectivity business.

In the wake of the spinoff of DirecTV into a separate asset 70 percent owned by AT&T, it would be tempting to say AT&T is unwinding its move into content ownership and media revenue models. That does not seem to be the case. 

Of the three areas of focus, connectivity represents one. Content distribution represents one. Content creation adds one. To be sure, AT&T generates a majority of its gross revenue from mobility alone. 

source: AT&T 

Still, video distribution generated 14 percent of gross revenue in 2020 and 4.4 percent of free cash flow, with the balance starting to shift away from linear and to streaming. That will change in 2021 as the DirecTV assets are moved outside of AT&T. The move still will produce about $1 billion in free cash flow for 2021, though.

Moving out the DirecTV results, as shown in the following chart, mobility generated 58 percent of free cash flow in 2020. Video content production generated 17 percent of free cash flow, just a bit behind the business wireline segment. 

source: AT&T

One way of describing matters is that AT&T free cash flow generation is led by mobility, with significant contributions from business fixed network customers and the WarnerMedia assets. Fixed network consumer operations generate about nine percent of free cash flow. 

Perhaps a key insight is that overall revenue growth is projected to be in the one-percent range. That is consistent with external estimates made for the global connectivity business as well. 

For a firm the size of AT&T, operating in mature fixed and mobile markets, long-term growth arguably has to come from lines of business outside the traditional core. The impact on cash flow generation could be even greater, as AT&T says the incremental profit margin for each HBO Max streaming customer is extremely high.

“We currently earn 90 percent in margin from each retail subscriber that we add,” said Jason 

Kilar, WarnerMedia CEO. That is akin to what other hyperscale application providers add when gaining an additional user. 

Software as a service margins might be in the 72 percent range. Facebook gross margins are in excess of 80 percent. So the HBO Max streaming service has free cash flow implications far higher than the linear DirecTV service, which might be in the 11-percent range. 

The point is that incumbent tier-one service providers (attackers are the exception) will have to create new lines of business, of some size, to fuel revenue growth. They simply are running out of runway to do so on the strength of their core connectivity businesses. 

So far, content ownership and video distribution have had the most immediate impact on gross revenues and free cash flow, though hopes are substantial for additional growth in business services related to edge computing and internet of things. So far, those businesses are young enough that they are not materially contributing to revenue or free cash flow. 

So critics might be underestimating AT&T’s commitment to content services.

AT&T Somewhat Skeptical about Fixed Wireless, But it Might be a Choice for 70% of U.S. Buyers

AT&T does not believe that customers consuming between one and five terabytes of home broadband data will be best served by a mid-band fixed wireless home broadband product.

“Well, the large consumption that we are anticipating over the next five years will be hard to meet with a wireless-only solution,” said Scott McElfresh, AT&T Communications CEO. There will be places where fixed wireless does make sense, he added. 

“There will be portions of the footprint that will not be economical to serve with fiber,” said McElfresh. “And we would intend to put at the edge of our fiber network this wireless C-band asset, along with our other mid-band spectrum to serve some of the limited use cases that we think are available for a fixed wireless solution.”

“But that's not our primary focus for that band, and that's not our primary focus to serve that heavy demand with broadband,” he noted.

At least in part, the issue is upstream bandwidth, where the difference between downstream data and upstream data has traditionally shown a 10:1 ratio. But AT&T CEO John Stankey argues that the ratio is heading to “something more like 5:1.”

As significant a change as that might be for a fixed network, the challenge is harder for a spectrum-constrained platform such as mobility, which never has the bandwidth provided by a cabled network. 

As always, firm strategy hinges on supplier assessment of their own strengths and weaknesses. T-Mobile and Verizon have much more to gain from taking home broadband share than does AT&T, and fixed wireless is the fastest, most affordable way to do so. 

T-Mobile has had zero market share in home broadband, as it has no retail fixed network business. Verizon has a retail fixed network business, but covers a small percentage of U.S. homes. 

Both firms stand to gain millions of accounts--especially where they do not presently offer any service--using mobile or fixed wireless. 

Comcast has (can actually sell service to) about 57 million homes passed.

The Charter Communications network passes about 50 million homes, the number of potential customer locations it can sell to.

Verizon homes passed might number 18.6 to 20 million. To be generous, use the 20 million figure. 

AT&T’s fixed network represents perhaps 62 million U.S. homes passed. CenturyLink never reports its homes passed figures, but likely has 20-million or so consumer locations it can market services to. 

T-Mobile and Verizon have the most market share to gain by deploying fixed wireless.  

“We choose to serve our customers that demand high-speed bandwidth with fiber, and we will utilize our wireless networks to serve those other niche use cases in areas where fiber economics do not make sense,” said Jason Kilar, AT&T WarnerMedia CEO. 

“We think that mid-band spectrum has its role,” said Stankey. “It has its role in being a premium mobility product.” But mid-band spectrum has issues supporting indoor coverage, he argued. “And we think there's better ways to kind of deal with what's going on inside most of the walls of society,” namely fiber to the premises. 

All that can be reasonably argued. But McElfresh also said “our vision would be to have over half of our portfolio or 50 percent of our network covered by that fiber asset” by about 2025, building at about a three million to four million annual rate. 

Proponents of fixed wireless might make exactly the same point: half of U.S. households buy broadband services running between 100 Mbps and 200 Mbps, with perhaps 20 percent of demand requiring lower speeds than that. 

So even if fixed wireless offers lower speeds than cable hybrid fiber coax or telco FTTH, it might arguably still address 70 percent of the U.S. market.

Must Telcos Become Platforms to Become Orchestrators?

Is it necessary for connectivity providers to become a full platform to generate significant revenues from cloud-based, internet of things and edge computing solutions? How much orchestration has to occur so connectivity offers add value? The answers may well determine how successful most telcos will be in the next era. 

Also, how much orchestration of value can occur--and provide revenue growth--without a full shift to a “platform” role? That might be the more-important question, as few telcos can realistically expect to become the center of a big ecosystem, and operate as a true platform. 

Today, virtually all telcos operate as “pipe providers,” not in the direct sense of supplying connectivity services, but in the broader sense of creating a product and then selling it directly to customers. Telcos have that in common with most businesses, in most industries, most of the time. 

source: Accenture 

Accenture consultants have used a tripartite model of the potential evolution of telco services, beginning with “connectivity provider” and growing to become a “connectivity-plus-plus” provider. That would include adding roles in edge computing, security services and internet of things, for example. 

The future role of “industry orchestrator” does not actually require a switch to a “platform” business model. It does require working with third parties to create new services bundling connectivity with line of business solutions, likely in some industry verticals. 

What is important is that such an evolution does not require any telco to become a platform. It “only” requires adding more value to existing connectivity products, to provide higher value, and thereby reap a higher share of “solution” revenues. 

source: Accenture 

In large part, the move “up the stack” or “across the value chain” towards end user applications is necessary simply because the core connectivity business is close to saturation, with little revenue growth from business-to-business or consumer lines of business. 

Growth will necessarily have to come from new products beyond connectivity, as hard as that will be to achieve. That is one reason the industry has created the multi-access edge computing concept. It might allow a richer value proposition solving more business problems than “communications.” 

source: IBM Institute for Business Value 

Think of the way hyperscale data centers have created ecosystems of application, support and connectivity options for customers colocated inside the buildings. While often not a switch to a full platform model--which would require that the data center operator gets a percentage of all transactions between partner use of its platform--still uses the principle of the ecosystem to provide higher value for colocated partners, and thereby drives real estate value and revenue. 

Discomfort is Almost Always an Indication that Free Thought Really is at Work

 "Free speech" necessarily makes rulers uncomfortable at times. So does "free thought." 

Unfortunately, ideas we disagree with sometimes also makes us uncomfortable at times. Some are moved to reduce that discomfort by banning ideas they do not agree with. That totalitarian impulse is no more praise worthy for citizens than it would be for government leaders. 

Valuation Issues an Obstacle to Moving Up the Stack

The connectivity business, once regulated as a monopoly, has been a slow-growth industry with valuation multiples reflecting slow growth. That poses a problem. If telecom companies decide to grow by acquisition, and they acquire software, technology or content assets, they face the impact of higher valuation assets.

In 2021, for example, enterprise value multiples compared to cash flow multiples (EV/EBITDA)--the value of all stock and debt divided by free cash flow--were 44 times in the internet software business and just 6.8 times for the telecom industry, according to Statista. 

source: Statista 

Information services had a 32 multiple while software had a multiple of 31. 

Essentially, telcos will be buying pricey assets with depreciated currency when acquiring assets “up the stack.” The alternative is an organic, “grow your own” strategy. That limits investment, but also tends to limit scale. 

source: Arthur D. Little 

That valuation gap exists even within some related infrastructure areas, as data center assets, or infrastructure suppliers directly supporting data centers, have valuation multiples in the 21 range, where mobile operators are valued at about 5.8 times EV/EBITDA.  

source: Bain 

The obvious issue is that acquiring assets “up the stack” at the application layer is costly. If one assumes that connectivity providers eventually will have to make such moves, the challenge is how to amass enough free cash flow to do so. 

Smaller connectivity providers will have scant chances to pursue such strategies, though. As small independent providers in any industry are squeezed out as scale providers emerge, smaller connectivity providers will have few choices but to manage costs as best they can until an exit event.

How Might B2B Sales Change, Post Pandemic?

With the caveat that we do not yet know how patterns will change in a few years, business-to-business sales practices during the Covid-19 pandemic have been forced to change. The big issue is whether the changes are permanent, and if so, at what level. 

While not all B2B sales situations are the same--varying by size of transaction, importance of transactions and degree of routineness or uniqueness--many professionals have said they have confidence in socially-distanced modes. 

At least early in the pandemic, sales professionals were fairly optimistic about socially-distanced sales practices, and most believed the practices would stay in effect for at least a year after the pandemic ends. 

source: McKinsey 

Like it or not, most B2B sales activities had to shift to virtual formats during the pandemic. Very few professionals reported the older model of sales teams visiting customers was still in place. 

source: McKinsey 

Many professionals also believe that remote sales have worked as well--or better--than the older face-to-face model. 

source: McKinsey 

Video and chat seem to have been widely adopted as the channels to replace in-person visits. 

source: McKinsey

Perhaps surprisingly, 70 percent to 80 percent of B2B decision makers said they prefer the remote interactions, or digital self service, where that is appropriate and possible, to visits from sales personnel. 

source: McKinsey 

One might suppose those findings are true when suppliers and buyers already have established relationships. Indeed, only 25 percent of sales professionals reported that the remote modes were “much less effective” or “someless less effective” with current customers. 

What might surprise you is that the same percentages were reported for prospecting for new customers. Just five percent of respondents suggested remote selling with prospects was “much less effective” than in-person approaches, with 20 percent saying remote prospecting was “somewhat less effective.”

source: McKinsey 

If sales professionals continue to hold those views after the pandemic is over, it is reasonable to expect rather wholesale change in many sales practices on a permanent basis, with less reliance on business travel for sales presentations or after-sales consultations. It is unclear whether there might be a shift to greater reliance on inside sales, but that seems a possibility.

It is conceivable that in some industries, there also will be less demand for attendance at business conventions and trade shows. On the other hand, it also is possible that the traditional value of trade shows--ability to meet with lots of potential customers in one location, with one sales trip--will remain highly valuable. 

It also is likely that attitudes could change over a few years, especially for support and prospecting with large accounts. While remote sales might be kept in place for “tactical” functions, “strategic” functions might still call for face-to-face sales calls.

The FTTH Sustainability Issue, as AT&T Faces It

This slide from AT&T’s analyst and investor day presentation March 12, 2021 illustrates the practical issues new fiber-to-home investments present. Average revenue per customer is about $58 a month. 

Take rates are about 34 percent. In other words, where FTTH is available, about a third of customers buy it. In many competitive markets, that is about as low market share can be and still provide any financial return at all. 

source: AT&T 

If we assume the existing locations are the most favorable, in terms of potential return, we might also assume that the business case could well be worse as less-desirable areas are added. That suggests a rather controlled expansion of FTTH by AT&T, as it must expect to build a network that strands two thirds of the access network investment.