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AT&T: Taking a Mulligan on Media

AT&T Logo 2020
(Image credit: AT&T)

About two years after it paid north of $100 billion (including assumed debt) for Time Warner Inc., AT&T is now floating scenarios including asset sales (DirecTV and possibly Cartoon Network), massive layoffs (in the “thousands”) according to published reports, and seems hell bent on getting back to its core wireless business (the seemingly only bright spot in its most recent financials). Essentially, five years after embarking on the bold new strategy that included doling out more than $150 billion to get into the media business, AT&T appears to want to take a mulligan. 

Also read: DirecTV Merger with Dish Shut Down Again by DOJ

Investors seemed to take it in stride. AT&T stock closed Oct. 13 at $27.75 each, down just 38 cents (1.35%) per share. So far this year the stock is down about 30%.   

News that AT&T has been thinking about selling DirecTV is nothing new. Heck, it’s been floated in one way or another practically since the day it bought the satellite TV giant in 2015 for $48.5 billion ($67 billion including assumed debt). That DirecTV has been bleeding subscribers for the past two years -- it has lost 6 million customers since Q2 2018 according to MoffettNathanson -- isn’t much of a surprise when you consider that the telco seems to have only purchased the company for its programming relationships in the first place. That was evident in the launch of DirecTV Now virtual MVPD service in 2016, a direct competitor to the satellite service and the subsequent abandonment of that platform for the direct-to-consumer offering of HBO Max this year. DirecTV Now, renamed AT&T Now in 2019, once touted as the future of the TV distribution business peaked at about 3 million customers and lost 68,000 subscribers in Q2. It now has about 1 million customers and is expected to lose more.

AT&T has reportedly restarted talks to sell DirecTV again, only this time, offers are coming in for about one-quarter of what the company paid for it, or between $15 billion and $20 billion. At the same time, AT&T has slapped a “For Sale” sign on its Xandr advertising unit -- remember when interactive ads were supposed to take advantage of the 170 million eyeballs AT&T controlled? -- and so far that too has been met with a tepid response. Other assets on the block include Vrio, formerly DirecTV Latin America, which pulled its initial public offering in 2018 and Warner Bros. Interactive, its video game unit. 

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

According to MoffettNathanson principal and senior analyst Craig Moffett,  the only untouchable business in the portfolio seems to be HBO Max, the streaming service it launched on May 27. WarnerMedia, which houses most of the assets acquired in the $108.7 billion purchase of Time Warner, has gone through one massive restructuring earlier this year, which resulted in senior management like WarnerMedia Entertainment chairman Bob Greenblatt and chief content officer Kevin Reilly being shown the exit, and is going through another shift in focus under new chief Jason Kilar that could mean “thousands” of layoffs in the coming weeks.  And though HBO Max seems to be what AT&T is banking its media future on, even some of those assets are not entirely safe from the hatchet.   

In his interview with the Wall Street Journal on Oct. 4, AT&T CEO John Stankey said, for example, that Cartoon Network becomes less valuable for every hour consumers watch its programming on HBO Max instead of the linear channel. But he said he wasn’t ready to jettison Cartoon yet.

Nevertheless, it still sounds a lot like Stankey was casting a line into the water to see if anyone would bite on the channel. And Moffett thought so too, calling his mention of the network in the WSJ piece “a trial balloon” for “potentially shopping” the channel.

Related: It’s Not TV, It’s HB(Uh)O 

There also seems to have been a semantic shift on the part of the AT&T CEO. 

According to Moffett, when Stankey speaks of AT&T’s strategy now, he talks of fiber rollouts and wireless networks. As far as the media business, gone are the mentions of AT&T as a  “modern media company,” replaced instead by words and phrases like  “de-emphasize,” and  “prune” and “strip out,” the analyst wrote. 

Doesn’t sound like the argot of a guy who wants to stay in the media business, does it?

While AT&T seemingly looks to unravel the business it spent a half-decade building, the wireless unit, while a brighter spot than the rest, also is feeling the pain of the pandemic, with plans to shutter 320 AT&T Mobility stores by the end of the year, on top of the 250 stores already closed earlier in 2020. 

Still, it was AT&T’s Mobility unit (which includes wireless) that fared best in Q2 -- revenue was down nearly 1% to $17.1 billion but adjusted EBITDA was up about 1% to $7.8 billion. It’s other units did far worse. Revenue at the Entertainment Group, which includes DirecTV, was down 11.4% to $10.1 billion and adjusted EBITDA fell 18% to $2.3 billion. At WarnerMedia, revenue fell 23% to $6.8 billion and adjusted EBITDA was down 13% to $2.1 billion

Moffett speculated that there could be three possible reasons for the recent urgency around its media assets: AT&T needs capital to participate in the upcoming federal C-band wireless spectrum auctions; it needs cash to make sure it can pay shareholders their dividend; or, it could all be a part of a routine annual review of its portfolio that found many of these businesses to be “strategically superfluous.”

Moffett stressed that he has no direct knowledge of AT&T’s reasoning for the layoffs and divestitures.

“But the pattern is clear: 1) AT&T is trying to sell almost anything that isn’t nailed down; 2) they are, by and large, getting a disappointing response to the assets being offered for sale; 3) they are therefore left to dramatically cut costs, even in businesses that are ‘core’ to their latest version of AT&T.” Moffett wrote.

Moffett isn’t alone in his thoughts. In a telecom black book report issued Oct. 13, Bernstein media analyst Peter Supino said that AT&T’s HBO and Turner are “suddenly sub-scale and their audiences are under assault. With management instability and difficult industry trends, we think Warner Media is the next shoe to drop for AT&T.” 

But Supino added things will have to get worse at WarnerMedia before they get better. 

Supino applauded AT&T management for its stewardship of the telecom business, adding that in “today’s rapidly evolving, increasingly competitive video market, we think they are way outside its circle of competence.”

The Bernstein analyst also points out that the company’s public subscriber target for HBO Max -- 50 million customers by 2025 -- looks easy given AT&T’s 170 million overall customer relationships, it’s not a slam dunk. HBO has about 34 million paying customers, all who will get HBO Max. But he projects that the company will get another 11 million customers over that period, mainly from high-level wireless customers who will get the service for free, leaving it with 45 million HBO Max customers by 2025. That does not include any subscriber lift from an ad-supported version of HBO Max, which should come next year, making the 50 million-subscriber target “plausible, but not easy.”

Supino estimates that the company also is counting on about $2 billion in annual advertising revenue for HBO Max, but he’s not sure how they will get there.

“HBO Max incremental expenses seem to require advertising revenue, or more subscribers than planned, to make money,” Supino wrote. “As relates to more modest strategies, today’s streaming landscape seems unfit for conservative plans. Pick your poison, we think.”

For what it is worth, while the wireless business is performing better than its other parts, it’s no great shakes either. Wireless makes up about 60% of AT&T’s valuation, but is far from a growth business. And it is going to need significantly more investment for 5G services. 

Part of that investment will have to go toward amassing spectrum, and the federal C-band auction set for December fits the bill. Moffett estimated that AT&T’s chief wireless competitor Verizon will have to spend about $20 billion in the C-band auction just to keep up with T-Mobile, the No. 3 wireless carrier that has a significant spectrum advantage. AT&T will likely have to spend even more, but where that money will come from is in doubt. Even if AT&T did sell DirecTV, Xandr and Warner Bros. Interactive, it could still be far short of the mark.

Moffett added that some reports have valued the video game unit at about $4 billion, but that it is probably worth about half that  amount. Xandr, on a good day, could go for around $2 billion. Add $15 billion to that for DirecTV and it would still be short of the $20 billion-plus it needs to spend on spectrum.

And that's assuming it even gets that much for DirecTV. Moffett noted that DirecTV’s subscriber base is shrinking at 18% per year, cash flow is declining at a high-teens percentage pace and it isn’t launching any satellites to beef up its aging infrastructure. That, Moffett wrote, would lead any potential buyer to assume that the business is being run for cash, and the only way for that to be attractive is for the buyer to get in at a very low multiple.

That too, is a problem for AT&T because of its industry leading leverage. According to Moffett, any deal for DirecTV that comes in below 3.5 times cash flow -- its current leverage ratio -- would make AT&T’s leverage worse, not better. And reports so far see 3.5 times cash flow as the high-end range of bids. Moffett estimates that DirecTV is worth about 3.7 times estimated 2021 EBITDA, or about $13.7 billion, which would put it in the same range as reported bids. 

Moffett has never been a fan of AT&T’s forays into media -- he called the DirecTV merger in 2015 a mistake at the time -- and he currently has a “sell” rating on the shares. Back in January, he told CNBC that media companies that have diversified -- like Comcast with NBCUniversal and AT&T with everything else -- haven’t fared too well.

Comcast is currently under pressure to unload or spin-off its content assets because of secular headwinds to that business, too.  

Buying into the media business was supposed to protect AT&T from the volatility of the wireless business and the company even today says that bundling content offerings with various wireless and wireline broadband packages make them more compelling and stickier to fickle consumers. In the Journal piece, Stankey said AT&T’s deal strategy is just the first step in a “wash-repeat cycle” that has fueled growth at the company for decades, adding that its balance sheet has always been a “strategic tool” that can be used to take advantage of opportunities. 

“Sometimes you walk away from an opportunity, but you did it knowing that the best bullet you could put in the chamber was the transaction you did,” he told the Journal.

And sometimes, you just take a mulligan.