Meet the new boss. Not quite the same as the old boss.
AT&T’s $48.5 billion merger with DirecTV took a yearlong backseat to more high-profile deals in the media space, but in the end, it was the deal that got done.
Practically sailing through the regulatory approval process — the merger closed on July 24, about 14 months after it was first announced in May — and with virtually none of the controversy surrounding the more high-profile (and eventually aborted) Comcast-Time Warner Cable union, it nevertheless created a new top dog among multichannel video programming distributors (MVPDs).
With 26.3 million video customers, AT&T now sits at the top of the heap, a spot formerly held by Comcast and its 22 million customers. It’s armed with the scale that its peers crave and are actively pursuing. And it did so without having to make onerous concessions.
While Comcast withdrew from its Time Warner Cable acquisition in April, after it became evident that the Federal Communications Commission wouldn’t approve the deal because of the sheer dominance the combined company would have over the broadband market, AT&T-DirecTV passed muster with only a few conditions. AT&T promised to expand its fiber network to an additional 12.5 million customer locations, pledged not to discriminate against online distribution services and agreed to maintain an internal compliance officer to make sure it is adhering to those conditions and offering broadband service to low-income consumers at discounted rates.
Out of the box, AT&T unleashed a torrent of discount offers aimed at pairing its newfound satellite video service with its wireless phone network, the second-largest in the U.S. It was the closest thing to the heretofore-unattainable quad play of video, voice, data and wireless that the industry has seen. It was a bold move.
AGGRESSIVE ON PRICE
Those discounts — $300 for switching lines and another $200 for consumers who purchase a new smartphone phone through the AT&T Next Plan — essentially would give DirecTV customers who switch wireless providers $500 for every line they switch. Potentially, a family of four that changes providers and buys four phones could ultimately reap $2,000 in savings, equal to more than a year of the satellite service’s top tier (the 315-channel Premier package) for free.
“I want Comcast to really regret the fact that they don’t have a wireless asset,” AT&T Internet & Entertainment CEO John Stankey said at the company’s recent Analyst Day.
Whether that plays out or not, AT&T isn’t sitting idly by and waiting for over-the-top and the rest of the competitive universe to run roughshod over its business. The telecom giant is firmly taking the bull by the horns and crafting — or at least trying to craft — a strategy that melds traditional TV viewing with wireless, mobility, retail and broadband.
By taking that bold stance and assembling the various pieces to put it in motion, AT&T is Multichannel News’s 2015 Distributor of the Year.
AT&T began to see the handwriting on the wall even before it started to pursue DirecTV last year. At the company’s recent Analyst Day, AT&T chairman and CEO Randall Stephenson added that while cord-cutting and cord-shaving continues to cut into the pay TV subscriber base, the answer could be in offering customers more flexibility in where and when they watch programs.
“TV everywhere is what’s being consumed by a lot of millennials and our research is bearing this out,” Stephenson said, adding that even as linear TV customers decline as household growth rises, it is a “manageable decline.”
Cord-cutting and cord-shaving will accelerate, Stephenson predicted, but the blow could be softer for AT&T given its additional scale and its product mix.
“What we’re seeing is [with] a $50 package on DirecTV, there’s not much difference in absolute margin to a $90 package on U-verse,” AT&T’s fiber-delivered telco TV product, Stephenson said. “There’s going to be a re-shifting of revenue and our expectation is that we can probably grow revenue per household for the foreseeable future.”
Other cable operators and purveyors of telco TV are following suit. MSOs are scrambling to pair their industry- leading wired broadband and WiFi networks with more content, while Verizon Communications, which has the fiber-based FiOS TV service as well as the largest wireless service in the country, recently launched go90, a mobile-only video service.
But according to AT&T senior vice president and chief financial officer John Stephens, AT&T is in a unique position with the DirecTV asset.
“The key for us is we have ability to deliver those services over multiple platforms,” Stephens said at the recent Goldman Sachs Communacopia conference. “A lot of others in the industry are going to be able to do it over just broadband or do it over just wireless. No one is going to be able to do it like us.
“We are going to be unique in being able to do it over satellite, over broadband, over IPTV or over wireless and we believe that changes the equation and puts us in a different position compared to any other competitor,” Stephens said.
For AT&T, the comparisons are fairly straightforward. While satellite competitor Dish Network may have the video product, it doesn’t have the broadband capability or the owner’s economic advantage over wireless; Verizon may have a broadband capability, but it won’t have satellite or the attendant scale in delivering and negotiating with content providers.
Stephens said AT&T’s approach is an integrated model that allows it to transform and transition to a mixture that also could include over-the-top video. “We understand those other business models — and I don’t mean to dismiss them at all, I’m very respectful of them — but I think we can do those and more,” he said.
BUILDING VIDEO SCALE
The deal also brings unprecedented scale to AT&T in a product line where scale has been lacking. The addition of DirecTV’s 20 million video customers to AT&T U-verse TV’s 6 million subscribers gives the combined company a level of programming clout that was heretofore nonexistent. That should translate quickly into savings on programming costs — AT&T has said DirecTV pays about $17 less per subscriber per month for programming than its U-verse customers, a gap that should close as future programming deals are negotiated.
But scale isn’t just a programming cost advantage. With additional size, the combined company can roll out new products more efficiently and more effectively market its offerings.
Scale has been the driving force in all of the deals leading up to AT&T’s DirecTV buy, only the definitions are different. For Comcast, which already was the largest U.S. cable operator with 22 million customers when it launched its $67 billion bid for Time Warner Cable in 2014, scale meant a greater opportunity to innovate and to further expand its broadband dominance. When Comcast withdrew its TWC bid in April, opening the door for Charter Communications’ $78.7 billion offer for the company, scale took on yet another different meaning.
Although Charter will more than quadruple its size to about 17.2 million video customers with the addition of TWC and Bright House Networks, CEO Tom Rutledge has said publicly that additional scale means a way to more efficiently market and distribute services, as well as lower programming costs.
UBS telecom analyst John Hodulik wrote in a recent note to clients that the additional video heft DirecTV brings to the table is key to AT&T’s overall growth, particularly as customer viewing habits change.
“DirecTV is critical to the company’s future, as video consumption on multiple screens continues to increase,” Hodulik wrote.
Stephens said the strategy is simple — give customers what they want, when they want it. The addition of DirecTV adds a compelling video product to what was already a popular wireless and wireline broadband offering. And by adding DirecTV, AT&T opens up a vast, untapped market for its wireless services. About 15 million DirecTV customers do not have AT&T wireless. On the flip side, 21 million of AT&T’s wireless customers don’t buy DirecTV service.
“We believe that there’s a real opportunity to bundle, to sell and put those things together,” Stephens said at the Goldman Sachs conference. “We’ve built out 57 million broadband locations and up until the DirecTV deal, about 30 million of them didn’t have a TV product. Now they do.”
The DirecTV deal also opened up all of AT&T’s 2,300 retail stores to a video product. Up until the deal closed, video was only available in stores within the U-verse footprint.
But this opportunity comes just as the entire pay TV industry, not just cable, is showing signs of decline. AT&T U-verse reported its first quarterly subscriber loss ever in the second quarter, shedding 22,000 video customers. At the same time, DirecTV lost about 133,000 net new subscribers.
Stephens blamed the losses on a combination of typical second-quarter seasonality — that is when college students disconnect service after the end of the school year and residential customers move to their summer homes — and a change in its promotional habits.
AT&T is moving more toward higher-end, more profitable, longer-term customers, and is pulling back on promotional activity, Stephens said.
“We have gotten out, measurably out, of the promo business in the second quarter and decided to be much more disciplined with our sales efforts and much more focused towards the long term value customers and so that was part of the impact,” Stephens said, adding that the activity around the DirecTV deal probably did have some small impact as well.
“With that being said, it’s transforming like everything else,” he said. “All parts of our industry are transforming, and that’s all that’s going to go on with pay TV and the over-the-top.”
AT&T also is in the middle of a massive buildout of its broadband infrastructure. The telco continues to expect to boost broadband speeds and now plans to expand its high-speed Internet service to reach more than 60 million customer locations by the end of 2018. The company also plans to expand its all-fiber broadband footprint, reaching more than 14 million homes when the build-out is complete.
Those plans haven’t been enough to staunch the criticism of the DirecTV deal, which many analysts have said is a desperate attempt to gain market share by paying too much for a declining asset.
“In the end, AT&T just bought yesterday’s technology in DirecTV at the all-time peak and are melding it with their mostly antiquated, copper-based fixed-line infrastructure,” Pivotal Research Group CEO and senior media & communications analyst Jeff Wlodarczak said after AT&T announced its wireless discounts. “This architecture, in my view, will inevitably lose no matter how much money they throw at marketing it.”
While DirecTV’s second quarter net subscriber loss was dramatic, customer growth has been on a steady downward path since 2009, when it reported a gain of 939,000 net new subscribers. According to DirecTV’s financial filings, it gained 663,000 net new customers in 2010; 662,000 in 2011; 199,000 in 2012; 169,000 in 2013; and 99,000 in 2014.
“All of this is AT&T’s problem now,” said Moffett-Nathanson principal and senior analyst Craig Moffett in a recent report. Moffett added that AT&T’s wireless discount offer in August — which, he wrote, “takes promotional discounting to a reckless new extreme” — sends a pretty clear message that the intention is to buy market share.
“Those kinds of offers will inevitably help unit growth, but not with profitability,” Moffett wrote.
AT&T has blamed the second quarter losses at DirecTV on stricter subscriber policies, something that Moffett has praised in recent reports. But that means AT&T will have to figure out a way to increase volumes without sacrificing profitability.
“That won’t be easy,” Moffett wrote in a recent report. “Beyond the lower programming costs for U-verse customers, the synergies from combining a copper broadband infrastructure and a satellite-TV delivered video business are limited, and substantial discounts will be necessary to get customers to adopt a bundle that includes wireless with satellite TV.”
AT&T thinks it can get there not just with heavy promotional activity, but through innovative pricing, packaging and keeping a keen eye on customer habits. The telco believes it has a tremendous opportunity in bundling its products together to take advantage of the 57 million homes it passes with its broadband and wireless networks. But in typical telco fashion, AT&T wants its results to speak for its actions.
“We’ve got to do some more work,” Stephens said at Communacopia. “The proof will be in our results, but, yes, we absolutely feel optimistic about the revenue opportunities. We are just going to be careful to get it done first and talk about it later.”
SIDEBAR: Cable’s Tortured History With Wireless Plays
The cable industry has a long, dubious past with the wireless industry, and one it would probably prefer to forget.
Cable operators first dipped into the cellular business in the 1980s, but had sold most of their licenses by the next decade, spooked by the high cost of network buildouts and cutthroat competition.
But like Al Pacino’s Michael Corleone in The Godfather: Part III, the wireless business kept pulling cable back in. Cable operators participated in Sprint PCS, the digital communications joint venture with the cellphone giant, with Comcast, Cox and Tele-Communications Inc. investing a combined $4 billion in the early 1990s. The partnership officially dissolved in 1999, when Sprint offered each of the partners Sprint PCS tracking stock in exchange for their interests in the partnership.
The cellular bug bit again in 2005, when Comcast, Cox Communications, Bright House Networks and Time Warner Cable all invested in a wireless partnership with Sprint that was initially supposed to include wireless video. Bandwidth constraints and rights issues hampered that part of the agreement, but the partnership continued on for three years, offering a wireless phone service dubbed Pivot (no relation to the cable network), that was sold by cable operator as well as in RadioShack stores across the U.S. That union also was scrapped in 2008 after disappointing sales.
Comcast, TWC and Bright House, along with Google and Intel, turned to WiMax pioneer Clearwire in 2008, investing a combined $3.2 billion to help the company build out a nationwide network. But bigger efforts by carriers like AT&T Wireless and Verizon Wireless in LTE technology and 4G overshadowed Clearwire’s plans, and by 2012 the cable partners were out of the picture. Sprint ended up buying the rest of Clearwire later that year for about $2.2 billion and has basically used its spectrum to augment its traditional wireless service.
Cable operators participated in wireless spectrum auctions too, forming SpectrumCo, a consortium of Comcast, Cox, Time Warner Cable and Bright House Networks that bid about $2.4 billion in the Federal Communications Commission’s 2006 Advanced Wireless Services auctions. But the operators apparently lost their appetite for cellular service in 2012, when the consortium sold its licenses to Verizon Wireless for $3.9 billion. That deal included an MVNO agreement with Verizon that has yet to be tapped.
Cox held on to its licenses and launched an ill-fated cell service in 2010, shuttering that offering by 2011 due to weak sales and an inability to gain access to “iconic” handsets, which most believed was a reference to Apple’s iPhone.
Cable turned its wireless aspirations to WiFi, which has been a wildly successful retention tool for its industry-leading broadband service. While reports have said Comcast was negotiating with Verizon to amend the MVNO agreement, most analysts believe WiFi will remain top of mind for cable operators.
Charter Communications CEO Tom Rutledge, one of the early cheerleaders for WiFi — he helped Cablevision Systems pioneer the service with its 2008 WiFi network buildout — has said there still may be room for cable in the mobility business.
“We’re going to be stepping into MVNO relationships in our new company [Time Warner Cable],” he said at a Goldman Sachs conference. “That may be a path forward. There’s also the ability to acquire licensed spectrum and begin to build assets in conjunction with WiFi assets. And you can actually put WiFi and licensed spectrum in the same radio camps that you hang on the poles.
“And so there is some combination, maybe of all of that, that creates a customer-relationship stickiness that doesn’t exist today,” Rutledge said.
— Mike Farrell
SIDEBAR: Building a Unified Video Front
AT&T’s acquisition of DirecTV presents significant opportunities and challenges.
While the post-merger company now has a combined U.S. video base of 26 million, taking advantage of this new scale will require it to establish a unified video platform.
AT&T has not outlined its full plan for that, but it’s been dropping plenty of hints.
Of recent note, the company hired Enrique Rodriguez, a former Cisco Systems and Microsoft executive who most recently was with Sirius XM, as executive vice president and chief technical officer. Rodriguez, who knows a lot about Mediaroom (the IPTV platform that currently powers U-verse TV), will be taking a lead role in the technical integration of the U-verse and DirecTV services.
AT&T has also tapped Ericsson (which bought Mediaroom from Microsoft in 2013) to assist as the pay TV operator “enhances” the telco’s TV platform and help AT&T evolve its satellite and wireline TV platform.
AT&T has also announced that it will use a derivative of DirecTV’s gateway-client “Genie” architecture to establish a more uniform, cloud-based video platform for the combined company.
— Jeff Baumgartner