AT&T and Time Warner merge content and distribution

AT&T’s proposed US$85.4 billion acquisition of Time Warner highlights its intent to diversify its business model and compete more effectively with over-the-top (OTT) players, such as Amazon, Facebook, Google and Netflix. It will gain new revenue streams from media, including the sale and licensing of content, as well as advertising. Like many other telecommunications service providers around the world, AT&T’s core fixed-line and data revenue is on a long-term downward trend. In the first half of 2016, its installed base of voice connections fell 11% to 42.1 million, while broadband connections fell 2% to 31.4 million. The number of video connections was also down by over 100,000 over the same period, which highlights the challenges AT&T is facing as US customers cut cable and satellite pay-TV subscriptions in favor of more flexible and cheaper online streaming services. Net neutrality rules also restrict its ability to counter competitive pressures by enhancing its own services over those offered by the OTT companies. AT&T’s move highlights the growing convergence of the media and telecommunications industries, as companies look to combine premium and exclusive content with direct-to-consumer distribution across multiple platforms. Further mergers and acquisitions are expected, especially in the US, as competition for advertising and content subscription services intensifies, while legacy voice and data revenue declines.

Time Warner adds premium content to AT&T’s DirecTV service

Time Warner has many attractive assets that will add to AT&T’s existing mobile and TV access services, including an extensive and popular content library and content creation capabilities across its three operating divisions. The Home Box Office division has approximately 131 million premium pay and basic cable subscribers for its HBO and Cinemax services, which include series such as Game of Thrones, Silicon Valley and The Sopranos. These are syndicated worldwide. Turner operates multiple news and entertainment channels, including CNN, TNT, TBS and Cartoon Network. It has access rights to premium sports content, including NBA and MLB. The third division, Warner Bros, produces and distributes approximately 20 feature films per year, as well as TV programs and video games. The deal will enable AT&T to compete more effectively against cable and OTT competitors by selling bundled mobile and broadband services with video content nationwide, as well as improving its streaming programs. It also reduces the cost and complexity of distributing Time Warner’s premium content, giving AT&T a distinct competitive advantage. AT&T will also have a chance to get certain content or distribution rights on an exclusive or early release basis, though the former is likely to be restricted by regulators. Overall, gaining priority access to Time Warner’s content would make AT&T’s current DirecTV satellite and U-verse triple-play packages more attractive, which would help reduce churn.

In the first half of 2016, Time Warner’s combined revenue totaled US$14.3 billion, which was down 1% on an annual basis, due to declines in the Warner Bros business. The contributing factors were fewer box office hits and a tough comparison to the previous year in the video game and television segments, due to the success of the Batman: Arkham Knight game and large licensing deals for The Big Bang Theory and Seinfeld in 2015. Importantly, its revenue will diversify AT&T’s capital-intensive business model, which is based on building out network infrastructure. Time Warner will contribute approximately 15% of the combined revenue and also adds new subscription and advertising revenue streams. In the first half of 2016, 39% of Time Warner’s revenue came from subscriptions to its premium channels, such as HBO, and newer streaming services, such as HBO NOW, HBO GO and MAX GO. Advertising accounted for 18% of its overall business, which is mostly generated by the ad-supported Turner division. It has been investing in this area, with analytic tools such as Targeting Now and Audience Now, to increase the relevance of its advertising placement. AT&T’s large mobile and TV subscriber base will enhance the value proposition for advertisers, especially given the growth of mobile video content consumption.

Countering the Netflix and YouTube effect

Digital-based business models have affected the music and publishing industries in terms of customer use and revenue flows. The rising popularity of Netflix and YouTube is having the same impact on the cable TV sector. Termed ‘cord-cutting’, many US customers are being turned off cable, fiber and satellite TV by high subscription costs (typically US$125 per month), poor customer service and having to pay for unwatched content. Many of these TV packages include over 200 channels. Internet alternatives offer on-demand, cheaper (US$10 to US$15 per month) and more flexible any-time and any-device services. Cord-cutting is accelerating, with more customers leaving than signing up. Approximately a million households deserted cable, fiber and satellite TV last year. Live TV viewing is also falling fast, especially among millennials, who prefer on-demand and user-created content from services such as YouTube. This is creating challenging conditions for content distributors in terms of selling subscriptions, and content providers in terms of selling advertising. To counter this, advertising rates and TV subscription fees have risen. It is estimated that nearly 50% of US households subscribe to at least one TV streaming service, with Netflix being the most popular, accounting for approximately 6% of total viewing. This is expected to more than double within five years.

Cord-cutting could accelerate faster if the lighter-weight streaming services also begin to show live TV on basic ad-supported channels. It would accelerate even faster if they could win lucrative live broadcasting rights to major sport events. Netflix and Amazon have already commissioned original programs and acquired exclusive content, including popular series such as House of Cards and Orange is the New Black. Content providers, such as Time Warner, Disney, Fox and NBC Universal, launched their own lighter-weight streaming services, including HBO Now and Hulu, to counter the threat and remain relevant. These bypass the cable, fiber and satellite distributors, such as AT&T, Charter Communications, Cox Communications and Altice. The biggest challenge is that those who cut the cord rarely return. Consequently, consolidation in the industry has accelerated, including the US$71 billion move by Charter Communications for Time Warner Cable and Bright House, as well as Altice’s US$27 billion purchase of Cablevision and Suddenlink. The need to sell triple-play (mobile, broadband and TV) services has become vital. Owning content providers is a now a viable alternative for service providers.

In Europe, the overall situation is different, but the trends are similar, as service providers expand triple-play services, especially TV. Many have launched TV services to counter the threat of OTT players. For example, Deutsche Telekom launched its Entertain TV mobile streaming service earlier this year, which offers 40 public and premium channels and a cloud-based recorder. It is working with German content providers, such as Arte and Mediengruppe RTL. The service is available to existing Deutsche Telekom IPTV customers for around US$6 per month and fixed-line customers for US$10 per month. Orange in France aggregates content from Canal+ and Netflix for its service. In the UK, BT entered the TV market by securing access to the English Premier and Champions Leagues for around £2 billion (US$2.4 billion).

Regulators will take a tough stance on the deal

AT&T’s bid for Time Warner is the largest M&A deal so far this year, and is expensive compared with the cost of just licensing content. It should be noted that a previous bid for Time Warner by Twenty-First Century Fox for US$80 million was rejected. AT&T’s bid can be viewed as being too good to refuse given the challenging market. But it is not the first tie-up between a telecommunications service provider and a media company. Comcast acquired NBC for a total fee of over US$12 billion when it bought a 51% stake in the business in 2009 and the remaining shares later in 2013. This combination provided Comcast, the leading cable provider in the US, with nearly 25% of all basic channels offered to cable subscribers. As part of the deal, it had to make some concessions, including hitting broadband coverage targets and specific content broadcast commitments. Comcast also acquired DreamWorks Animation for US$3.8 billion in 2016 to increase its content creation capabilities.

Verizon has recently taken a different approach by diversifying its business by gaining online content and advertising, with proposed deals for AOL (US$4.4 billion) and Yahoo (US$4.8 billion). Further acquisitions could be triggered by AT&T’s move, with Charter Communications, Cox and Altice the most likely to make moves for content companies to improve their negotiating capabilities with regards to content licensing. Potential content targets could include AMC Networks and Discovery Communications. Even a counterbid by Apple is a possibility, given its growth in services and declines in hardware. It is highly unlikely that either a European or Asian service provider will acquire one of the US-based content companies, but instead could buy local players. For example, Telefónica in Spain acquired Canal+ España for €707 million (US$770 million) last year to add to its Movistar TV service.

Many concerns were raised at the time about the Comcast-NBC deal. These centered on limiting the availability of content to a single large player, and therefore reducing customer choice and potentially raising prices. Nevertheless, the deal was pushed through, though, more recently, regulators have blocked deals deemed anti-competitive, such as Comcast’s bid for cable provider Time Warner Cable. The same concerns have been raised again following AT&T’s announcement. Its timing, however, just before the US presidential elections, has made the Time Warner deal more political. Donald Trump has already said he would block the transaction if elected, while Hilary Clinton advocated a diligent review process. Regardless of the election result, regulators are likely to take a tough stance, which is already creating uncertainty in both companies’ stock prices. Strict concessions are expected, given AT&T’s position as the leading pay-TV provider, the second largest mobile provider and a top three broadband provider in the country. The deal is a vertically integrated one, like the Comcast-NBC deal. This means there are limited overlaps but inherent conflicting factors. On the one hand, consumers benefit from greater choice and wider distribution of content, but cable, fiber and satellite service providers benefit from more exclusive content. This, of course, is being funding by the ongoing availability of cheap finance.