AT&T: Merger Will Cut Content Costs

TELCO CITES LICENSE FEES AS RATIONALE FOR DIRECTV DEAL IN SEC FILING
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AT&T’s latest explanation of why it wants to merge with DirecTV spells out some of the expected savings in a key cost area: programming for AT&T U-verse.

It also highlights the relatively expensive hit new pay TV entrants like Uverse have to absorb in order to compete against incumbent cable and satellite providers — and the benefits AT&T hopes to achieve from selling a bigger bundle of video, voice, data and wireless services to its new pay TV base, which would rise to 26 million customers after the merger.

AT&T said in a securities filing that adding DirecTV’s 20 million video customers could help shave more than 20% off the rates AT&T now pays for programming.

U-verse TV programming now costs AT&T about 60% of total video revenue, it said — a huge amount, given that programming expenses for cable and satellite operators fall generally in the mid-40% range of video revenue.

AT&T said the combination with DirecTV will generate about $1.6 billion in cost savings over the first three years, most of that coming from programming costs. A big reason to add scale in the pay TV realm is to pay lower rates for programming. That can be seen in the chunk of video revenue that goes to programming expense at the top publicly traded cable operators — Comcast, Time Warner Cable and Charter Communications. Content costs represented about 44% of Comcast’s 2013 video revenue, 47% for TWC and 53% for Charter.

At 60%, it seems that AT&T’s U-Verse TV, which has about 5.5 million customers, is paying rates similar to what Charter pays now.

But Charter, with 4 million customers, still pays less than U-Verse, despite having 1.5 million fewer video customers.

Even after adding DirecTV, and rising to 26 million video subscribers, content costs as a percentage of revenue would be just 4 percentage points lower than Comcast — despite having 4 million more customers.

AT&T had to pay higher rates for programming when it was entering the market, Pivotal Research Group principal and senior media & communications analyst Jeff Wlodarczak noted.

Even five years later, those rates are still higher than their older peers.

The same held true for DirecTV and Dish Network when they first launched in the late 1980s and early 1990s, Woldarczak said.

Over time, that premium begins to level off — DirecTV’s content costs represent about 47% of its revenue, about on par with Comcast.

“They [programmers] have had a nice little arbitrage,” Wlodarczak said. “When the satellite guys came in, they were paying a pretty significant premium to cable because they had no leverage.”

When telcos Verizon Communications and AT&T entered the pay TV business, they were focused on rolling out service and signing on customers and not necessarily on playing hardball with programmers, he added.

Wlodarczak said AT&T could get to that 20% cost reduction relatively quickly, especially if it can “flip the switch” and convert the U-verse TV deals to DirecTV rates. Whether or not it will be able to do that is unclear, but it does seem likely that the programming costs for U-verse’s 5.5 million customers would be in line with what DirecTV pays for its 20 million customers.

As for revenue gains that could come from the merger, AT&T said it would offer a video, voice and fixed-wireless broadband product to 70 million homes across the country and a more competitive bundle of video and broadband for another 45 million homes. The latter would include its Project Velocity IP footprint, a wireline and wireless broadband initiative targeting 24 million homes, and by expanding its GigaPower ultra-high-speed service to an additional 2 million homes.

If programming costs are calculated as a percentage of overall revenue, the percentage paid drops by about half when all three revenue streams are considered.

And with plans to add a fourth product to the mix play — wireless phone — AT&T could have another leg up on its competition after all.

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