- A deal for Time Warner supports AT&T's 2015 acquisition of DirecTV, which is already showing signs of decline.
- Doubling down on media may not be AT&T's wisest move as technology giants like Google and Amazon spend billions on content.
- It is also possible Time Warner is simply a melting iceberg that may keep losing value.
With top executives for AT&T and Time Warner expected to take the stand this week in defense of the companies' planned merger, the communications company is framing its acquisition as a quest for survival against tech giants like Google, Facebook and Amazon.
Oddly, AT&T may be better off losing in the long run.
AT&T wants Time Warner to sustain and bolster its 2015 $67 billion acquisition of DirecTV. AT&T has more than 25 million paying video subscribers through DirecTV and U-Verse, though it lost more than 1 million in 2017. These customers will keep paying AT&T as long as the traditional pay-TV bundle survives, and buying Time Warner — which includes networks CNN, TNT, TBS and HBO — allows AT&T to have a say in the future of content.
But buying Time Warner may not be enough to thwart the freight train of competing products from Netflix, Google's YouTube, Amazon Prime and potentially Apple. AT&T says in court filings it needs Time Warner to compete. Yet it's possible the train has already left the station, and AT&T is better off not spending $85 billion to support a dying pay-TV model.
"AT&T has a strategy, but it might not be the right one," said Craig Moffett, an analyst at MoffettNathanson.
"The financial cost already committed to DirecTV is enormous and has become a huge drag on the company. AT&T runs the same risk with Time Warner. If the secular decline of linear cable networks happens faster than forecast, AT&T could find itself in very deep water."
AT&T argues it can better compete with Netflix, Amazon Prime and YouTube by offering a lower-priced digital, nationwide bundle of TV programming. Right now, it's got a $35-per-month product called DirecTV Now. AT&T says acquiring Time Warner will allow it to create "new video products better suited to mobile viewing," according to a March 9 court filing.
AT&T writes that it "has been unable to obtain sufficient distribution rights from unaffiliated programmers to achieve its vision for the next wave of products and packages, including lower-cost, ad-supported services."
It adds "the merger will solve that problem."
While futuristic packages of video content sound nice, AT&T hasn't explained exactly what it has in mind. But there's another reason AT&T wants Time Warner — and it's the very reason the government sued to block the deal in the first place.
Owning Time Warner gives AT&T a hedge in case customers continue to flee DirecTV and U-Verse for other packages of video programming. If competing services, such as YouTube TV, want Time Warner programming, they will have to pay for it. Buying Time Warner gives AT&T some piece of the pie, even if DirecTV flounders.
And, to be clear, it is already floundering. Revenue and earnings have fallen in the past year as customers drop the satellite TV service for alternatives.
"It's not crazy to think that $67 billion acquisition looks more like a $25 billion acquisition soon," said Moffett.
Growth at Time-Warner's HBO, on the other hand, continues to soar.
If courts decide that AT&T can't own Time Warner, it will be because AT&T could threaten to keep Time Warner content exclusive to DirecTV and not sell it to other distributors. This could lead to two results:
* AT&T could sell Time Warner content to competing distributors for higher prices, thus leading to rising TV bills, or
* AT&T could hold the content hostage and reap the rewards when customers cancel their current cable operator and switch to DirecTV.
"The judge will be looking at whether the combination of assets between AT&T and Time Warner will undermine competition by making content unavailable or more expensive to other companies that need it," said Logan Breed, an antitrust lawyer at Hogan Lovells. "This is the first case in 40 years that will really probe vertical integration."
AT&T argues this threat is illusory because withholding programming isn't a sound economic decision. AT&T says it could make more money by collecting affiliate fee revenue from distributors and online providers of video than it would from an unknown number of customers switching its pay-TV or wireless service to AT&T. Plus, HBO already sells its service separately, outside of the cable bundle, through HBO Now. AT&T would risk alienating more than 2 million subscribers by revoking this product.
But in fact, the entire acquisition is built on shaky business premises.
Here are four reasons AT&T may be better off if U.S. District Court Judge Richard Leon rules in favor of the government and blocks the deal.
Pay TV is shrinking. Doubling-down on content to support DirecTV may not matter if the entire pay-TV business is in irreversible secular decline.
Even if HBO is growing (some of that growth is from AT&T giving away HBO subscriptions last year with the assumption its deal would go through), U.S. pay-TV households are shrinking at an alarming rate.
Only 79 percent of U.S. homes subscribed to some form of a pay TV service last year, down from 88 percent in 2010, according to a study from Leichtman Research Group. That's not good news for CNN, the CW, and Turner Broadcasting, which survive on eyeball-driven affiliate fees and advertising. It's possible Time Warner is a melting iceberg.
Losing could set a precedent that also weakens competitors, including tech giants. If AT&T loses, and the government applies a new, strict anti-vertical integration precedent to the largest technology companies, that could stop them from acquiring media companies themselves. It could also prevent them from one day branching out into wireless distribution, AT&T's core business.
"Whatever this judge says in his opinion will carry a lot of weight in future analyses of vertical transactions," said Breed.
A ruling against AT&T would also hurt its direct competitors. Other wireless and cable companies would conceivably have to give up on any dreams of vertical integration. It's unclear how a decision would affect Comcast, which is already vertically integrated through its ownership of NBC Universal, CNBC's parent company.
Time Warner could get caught in an expensive bidding war for content. Technology companies are increasingly bidding on content, the lifeblood of HBO.
Netflix has already committed $8 billion for 2018. Apple may spend up to $4.2 billion on original content by 2022. YouTube is ramping up production of original series. Amazon spent $4.5 billion on 2017's video content, according to J.P. Morgan estimates.
Major sports rights are tied up for a while — NBA games will air on Turner's TNT through the 2024-25 season. Sunday Ticket, which AT&T already owns, is locked up until the end of the 2022-23 NFL season.
Still, what happens if Netflix, buoyed by a $135 billion market valuation that's close to double all of Time Warner, outspends HBO on the most promising new shows? And if not Netflix, what about Amazon, Google and Apple?
The same question applies to sports rights. Facebook will exclusively stream 25 Major League Baseball games this year. It's a tiny deal — but could be a precursor of what's to come.
These are media-rights deals, not mergers. Chances are the government isn't going to block them. Instead of protecting AT&T from technology companies, owning Time Warner may make AT&T even more vulnerable to brutal competition for content.
Buying Time Warner will increase AT&T's massive debt load. It's already about $125 billion and would balloon to about $175 billion if the deal goes through. While tax reform has given AT&T some relief, "you still have to be concerned with that level of leverage," Moffett said.
"The more you get enamored with a strategic idea of what you can do with an asset, the more you overlook the warts," Moffett said.