White: AT&T Deal Unlocks Potential

But Shares of Both Companies Slide In Wake of Announcement
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DirecTV CEO Mike White said his company’s pending merger with AT&T will unlock tremendous growth potential for the satellite giant, even as investors sent shares of both participants southward amid doubts about the benefits of the merger.

Shares of both companies were down about 2% in early trading Monday – DirecTV was priced at $84.34 each (down $1.84) while AT&T logged in at $35.90 each (down 84 cents). The stocks have since improved slightly – AT&T shares closed Monday down 1% (36 cents) to $36.38, while DirecTV shares closed down 1.7% ($1.53 each) to $84.65 per share.

While the declines were small, they are in sharp contrast to what usually happens to the seller in such mega-deals – in contrast, Time Warner Cable stock was up 7% on the day it announced its $69 billion deal with Comcast – and could point to concerns investors have about the deal outside of potential hurdles to regulatory approval.

On the Monday conference call, White, who will continue to head up the DirecTV unit after the deal closes, said the merger offers the satellite giant an opportunity for growth.  And while White and Stephenson wouldn’t mention it by name, it appears that the Comcast/Time Warner Cable merger – which will create a 30-million-subcriber cable powerhouse –  influenced their decision to seek out a deal.

DEAL 'CAUGHT STEAM'

Stephenson said although AT&T and DirecTV have talked “off and on” over the years, the idea of a combination “caught steam this year.”

White said that what accelerated talks was “the change in the trends in the industry,”  including the shift in the importance of broadband and competitive content costs.

White also sees a big customer service opportunity in the deal, allowing DirecTV to offer more products in a single truck roll.

“To me the real opportunity is growth,” White continued.  “For us this is a real unlock, it  unlocks our way to better serve rural areas, when you think about the 15 million [customer] build out of rural areas. We have been salivating to be able to do [a] one bill and one install experience for the customer and not have two different people show up on two different days, to run it from one call center. This is an enormous opportunity for DirecTV that’s one of the things we could not have gotten with any other partner.”

STANDALONE BROADBAND PLEDGE

Both AT&T and DirecTV management touted the obvious benefits of the deal – they expect about $1.6 billion in annual cost synergies after the third year; they will greatly expand their broadband footprint (passing 70 million homes), including expanding their high-speed data footprint by 15 million homes in mostly rural areas. The combined company will have about 26 million pay television customers with the addition of DirecTV’s 20 million satellite subscribers and they have pledged to make standalone high-speed Internet service for an over-the-top video offering available to customers who want it.                                                                                                                                                                       

But there are still some questions concerning the merger. AT&T CEO Randall Stephenson said that AT&T will continue to offer its U-Verse fiber-based video product in its existing markets, a move that would seem to either cut out DirecTV in those areas or force both sides of the  company to compete against each other in some markets. Neither company has secured the necessary content licenses to offer an over-the-top service, although they both say with their added heft, that shouldn’t be a problem.                                                                                                  

“When you’re talking to the content folks as a company with 100 million wireless subscribers, a 70 million  [subscriber] broadband footprint and 25 million video subscribers, I think they see us differently,” Stephenson said on the call. “There is money to be made from both sides to distributing this content in unique and different ways. I think we are going to have a lot of new models emerge as  a result of putting these two companies together.”

On the U-Verse/DirecTV side, Pivotal Research Group principal and senior media & communications analyst Jeff Wlodarczak said in an e-mail message that it appears the two will compete in some markets.

“But that does not mean they are spending marketing dollars,” Wlodarczak wrote. He added that at his reading, U-Verse would also not be able to offer NFL Sunday Ticket, the out of market National Football League package that is exclusive to DirecTV.

“In the end you have to think at the very least U-Verse video will change its name to DirecTV,” Wlodarczak wrote, adding that a satellite/fiber video offering could make sense in some markets.

“In the end you roll [out] upgraded terrestrial in urban markets (where satellite is weak) then you focus on pushing satellite in a U-Verse package with a much more robust data offering,” he wrote.

DIRECTV DOWNGRADE
Wlodarczak lowered his rating on DirecTV to “hold” from “buy,” citing his belief that the $95 price undervalues DirecTV – he thinks it’s worth at least $115 per share – and noting that DirecTV would have to pay a break-up fee to AT&T if it accepts another bid, but there is no break-up fee in the event the deal does not get regulatory approval.

“Effectively it appears that DirecTV had one bidder and they accepted that bid, which would seem to indicate concern around DirecTV's long term competitive positioning,” Wlodarczak wrote in a note to clients. “We view most of the AT&T concessions offered to get a deal through regulatory hurdles as, arguably, trivial and believe there is a 40% chance of the deal not being approved by regulators (mainly driven by the fact that this transaction will reduce competitors from 4 to 3 in a material % of the U.S.).”

Stephenson said that the method of video delivery will depend on what the customer wants – satellite fiber and wireless.

“We’re going to have a number of media by which we deploy and deliver video,” Stephenson said. “I’m not getting too hung up on what the transmission medium is. We’re going to find the lowest cost, most efficient transmission medium for whatever  screen the customer is looking at and whatever architecture we have for that particular arrangement. What you will see over time, over a 3-4 year period, you will see the experience begin to merge. So the user interfaces will all look and feel the same; the content will look and feel the same; the  cont arrangements over time will look the same. That will be the elegance and the beauty of being able to deliver this customer experience we’re talking about. I don’t see it displacing our fiber-fed video product in our U-Verse footprint.”

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