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AT&T and DirecTV: Divorce Won’t Be Easy

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It was only about five years ago when AT&T, opening its checkbook wide to break into the pay TV distribution business in 2015, touted its $48.5 billion purchase of DirecTV as the beginning of a new era in media. Armed with 26 million subscribers -- including about 5.7 million from its existing IPTV business U-verse -- AT&T was going to transform the way people watched TV.

Fast-forward five years and AT&T, for what seems like the umpteenth time, is looking to sell DirecTV to anyone with a pulse. According to reports, the telco is willing to part with a little more than 50% of the satellite giant for about $20 billion. 

Related: Will AT&T-DirecTV Merger Fly? 

DirecTV still has about 16.3 million subscribers, throws off about $4 billion in free cash flow a year and is still a force in rural America. The bad news: it is losing customers at an 18% annual rate (about three times the pace of traditional cable operators), and with the upcoming RDOF auctions, some cable companies (like Charter) could aggressively deploy broadband in rural areas. Broadband is what helped kill DirecTV in urban markets, and a lot of analysts believe it could be the final nail in DirecTV’s coffin. 

It’s a shame, because less than a decade ago DirecTV was basically the gold standard for pay TV, leading JD Power customer satisfaction surveys, pioneering innovative programming (NFL Sunday Ticket) and technology (digital TV) and causing cable operators fits. Now, AT&T has reportedly stooped to letting certain non-DirecTV subscribers sign up for Sunday Ticket -- and for at least the past year it has seemed that AT&T has lost interest in the former satellite TV jewel.

AT&T has been not-so-quietly removing the DirecTV brand -- so important when it bought the satellite giant in 2015 -- from practically every product. DirecTV Now changed its name to AT&T TV Now last year. The satellite service is still called DirecTV but the flagship distribution product is called AT&T TV, an IP-based service of questionable subscribership. On the streaming side, HBO Max is the dominant brand, a product of its 2019 purchase of Time Warner Inc.

In a blog post, MoffettNathanson principal and media analyst Craig Moffett wrote that while he believes AT&T would be better off without “the albatross that is DirecTV,” he doubted it would be able to find a suitable buyer. 

Because the biggest question surrounding DirecTV is and always has been its valuation. Aside from the aforementioned subscriber erosion, the analyst points out that DirecTV’s ARPU growth -- in the past in the mid-single-digit percentages --will likely decline to low single digits, which would affect revenue and cash flow growth negatively.

And then there are the purported suitors AT&T is courting for DirecTV -- private equity players. According to the Wall Street Journal, which first broke the story that AT&T was (again) exploring its options for DirecTV, AT&T was talking to Apollo Global Asset Management and Platinum Equity as potential buyers. 

But private equity usually looks for one of three things when they are considering a purchase -- an undervalued asset (nope), an underappreciated or emerging market (again, nope), or an asset that can be monetized through an IPO or a sale (maybe).

Moffett said an IPO is not a feasible option, and a sale to satellite TV rival Dish Network, while possible, isn’t as attractive as it seems to be.

Dish, which is deep into building its own wireless network, has lost fewer satellite TV customers because it has focused on rural subscribers, according to Moffett. But that doesn’t mean slapping it together with DirecTV will make things better.

Merging with Dish would only improve the subscriber erosion to 15% per year, according to Moffett, adding that with Charter and others planning to increase rural broadband buildouts, the picture is even gloomier.

“If we see a huge post-COVID stimulus/infrastructure bill next year targeting broadband expansion, as seems likely, then the defensible rural segment will all but disappear,” Moffett wrote.

Even analysts more open to a sale to Dish, do so with a healthy dose of caution.

In a note to clients Monday, Barclays Research media analyst Kannan Venkateshwar said that a Dish/DirecTV merger, while rejected by legislators in 2002, is more likely given how the market dynamics have changed. But he warned that the current administration has not been too willing to make things easy for AT&T. 

“Even if the deal is approved ultimately, the political environment could result in an inordinately long approval process which may change the economics and rationale of the deal in the interim given the acceleration in cord cutting,” Venkateshwar wrote.

A buyer could run the business for cash, but Moffett added for that to be attractive to a private equity buyer, they would have to get in at a very low entry multiple.  

But AT&T is constrained there too. Moffett wrote that after operating leases, pension and post-retirement health benefit obligations and whatnot, AT&T’s leverage ratio is about 3.5 times EBITDA, already pushing the limit of its investment grade credit rating. Selling DirecTV at a lower multiple would only make AT&T’s leverage ratio higher, which is not an option, he wrote.

“Would any buyer pay more than 3.5x EBITDA for DirecTV?” Moffett asked. “We doubt it.”

So, five years into its multi-billion dollar marriage, breaking up won't be that easy for DirecTV and AT&T.