Three years after it said it would spend more than $100 billion (including assumed debt) for Time Warner Inc., AT&T is a pure-play phone company again, agreeing to spin off its WarnerMedia business into a separate entity with Discovery Inc., effectively ending its years-long experiment in the TV distribution and content business.
This is the second spin-off the phone giant has made in about three months. In February, it said it would spin off DirecTV in a separate, publicly traded unit that would include private equity giant TPG, for about $16 billion, or less than half the $49 billion ($66 billion including debt) it paid for the asset in 2015.
With the Discovery-WarnerMedia deal, AT&T has effectively given up on its media strategy, which a mere three years ago was supposed to be the foundation of the new AT&T. Now, AT&T gets $43 billion for an asset it paid $85 billion ($108.7 billion including assumed debt) for in 2018, and becomes a pure-play phone company again.
In a research note, Bernstein media analyst Peter Supino said that AT&T management came to the realization that Time Warner executives did when they decided to look for a buyer three years ago: the new content model is tough.
“We think this merger discussion evidences AT&T's concern about the cost to make HBO Max a long-term winner in global streaming,” Supino wrote. “We believe that the capable [Time Warner Inc.] management team was elected to sell the company because it could not solve [Time Warner’s] market share problem as a public company prioritizing profits. In that context, we have thought it almost inconceivable that the phone company would solve that same problem. That the phone company is anxious about its adjusted leverage approaching 3.8x makes it even less likely to lead Warner Media to glory.”
Supino’s Bernstein colleague, media analyst Todd Juenger, wrote in a note to clients that the WarnerMedia-Discovery deal is proof that neither company believed it had the scale to make streaming a success alone. But he had doubts that this transaction will make the combined company big enough.
“Taking two businesses where the vast majority of the cash flow is derived from linear TV, which is in our opinion a structurally impaired business (with cyclicality as well), does not create a better business,” Juenger wrote.
In a conference call with analysts about the deal on May 17, AT&T CEO John Stankey talked a lot about 5G and fiber, two things that probably haven’t been top of mind for many investors as the company struggled with DirecTV subscriber losses and concerns over HBO Max’s sluggish customer growth. Now, with the distraction of the media business gone, maybe they can focus on what they appear to be good at -- the phone business.
AT&T is coming a bit late to that decision. Its chief wireless rival, Verizon Communications, came to that realization a few years ago, after dipping its toes in the content creation and distribution businesses. Earlier this month it cleared the media deck with the sale of its remaining media assets to Apollo Global for about $5 billion. Verizon still has its Fios TV pay TV distribution business, but it's clear the real emphasis there is on broadband.
Now AT&T gets to focus on broadband too. During a conference call with media, Stankey said the goals for the new AT&T would be “simple and straight-forward”: growing its wireless network to reach 200 million POPs by the end of 2023, and to more than double its fiber footprint to 30 million homes by the end of 2025. That sounds like a phone company talking to me.
For WarnerMedia, which has been on a bit of a roller coaster ride in the past few years, it gets an owner that actually knows the TV business. In a conference call with analysts, Discovery CEO David Zaslav, who will head the new entity, noted that he’s known a lot of the media unit's employees for 30 years. Zaslav had a long career running NBC Cable before joining Discovery about 15 years ago, and he has managed to grow that company through acquisitions and organically. Now he’s leading it into the next stage.
That’s really important. Whatever your thoughts about WarnerMedia under the watchful eye of AT&T management, it’s pretty obvious that the old structure wasn’t working. Since taking over Time Warner in 2018, WarnerMedia has had three CEOs -- Stankey, who became CEO of AT&T last year; Bob Greenblatt, who was fired after about a year on the job; and Jason Kilar, the Hulu founder who suddenly made himself extremely available in the past few weeks, keynoting the MoffettNathanson Media & Communications Summit conference on May 13 and becoming the subject of a sprawling Wall Street Journal profile on May 14.
According to at least one outlet, in hindsight it appears Kilar was beginning to see the handwriting on the wall, and was trying to put himself and his accomplishments out there just in case he had to make a sudden move. The New York Times reported Monday that Kilar was assembling a legal team to negotiate his exit.
Kilar was thrust into the role after Greenblatt, who had past successes with Showtime and NBC, was shown the door. About seven months after taking the job, Kilar caused some uproar in the talent ranks when he unveiled a plan to shatter theatrical windows, opening up Warner Bros. Studios’ entire 2021 slate to streaming and theaters simultaneously. WarnerMedia is going back to the old windows for its 2022 movie lineup.
On the conference call with media, Zaslav called Kilar “a fantastic talent,” but passed to Stankey on the call when asked about the Hulu founder’s future in the new company.
Stankey said that Kilar remains the CEO of WarnerMedia, but that Zaslav “has got a lot of decisions to make on personnel and how things are structured moving forward during this transition period, as he works his way through it, I’m sure he’ll be talking with folks about where that’s going.”
Not exactly a ringing endorsement.
Zaslav said that the new company will have a new name, coming in the next week or so, and that the idea is to fully integrate Discovery and WarnerMedia. Whether that means that the two companies’ respective streaming services will be combined as one, isn’t quite clear. Pricing also is going to be key. Currently, HBO Max is the most expensive DTC streaming service at about $15 per month and Discovery Plus is at about $4.99 ($6.99 for an ad-free version) per month. HBO Max is planning to launch an ad-supported version in June, which some reports say will be priced at about $9.99 monthly. How Zaslav melds and prices those two offerings is still a question, but most analysts believe that a $25 HBO Max/discovery plus service is hopefully not in the cards.
Juenger wrote that if the plan is to not offer the Discovery Plus and HBO Max products separately, then the price of one or both has to come down significantly, with no change in content. That, he said, would most likely lower the value of the companies’ current streaming plans.
“For this new suite of streaming offerings to be more valuable than the current plans, one would have to believe that by sacrificing ARPU of one or both, there would be enough incremental additional subscribers to more than make up for that,” Juenger wrote.
That could be hard because while some analysts (including Juenger) have noted how this deal will have a big impact on the linear channels, the real reason behind this is the failure for HBO Max to live up to expectations. While HBO Max has about 44.7 million subscribers, more than half of those are estimated to be linear HBO customers. Discovery, which launched its Discovery Plus streaming service in December, has about 15 million customers. While many of those are getting service for free through a promotion with wireless company Verizon, that is still strong growth with a lineup of reality shows that admittedly don’t have the same cachet as Game of Thrones or Mare of Easttown. Zaslav has said that Discovery makes more money per subscriber from streaming than from linear TV, and that the average viewer watches Discovery Plus about three hours per day. Kilar said at the MoffettNathanson conference that HBO Max engagement is about two hours per day per active account.
It’s not like AT&T didn’t have high hopes for content when it bought Time Warner in 2018, saying that it would combine the programmer's iconic HBO premium network and linear channels like TNT, CNN, TBS, Cartoon Network, TCM and others with its state-of-the-art telecom services. Chairman and CEO at the time Randall Stephenson was quick to talk about the 100 million-plus subscribers that AT&T had through its wireless services that would be able to access WarnerMedia content. Three years later, Stephenson retired and Stankey, who had run WarnerMedia shortly after its purchase by the telephone giant, isn’t talking as much about engagement anymore.
One lesson phone companies seemingly have to learn year after year after year is that the TV business is not the phone business. And a climate where Disney Plus, The Walt Disney Co. 's streaming content juggernaut, has more than 100 million subscribers but still took it on the chin for not growing fast enough, just shows that streaming, as it is currently modeled, requires an unprecedented level of scale and engagement. No one has been able to figure it out yet. Now, it’s going to be David Zaslav’s problem to solve.
This story was updated to correct the pricing of the Discovery Plus streaming service.
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