Why Would DirecTV Merge With AT&T?

AT&T (NYSE:T) has entered into a definitive agreement to buy DirecTV (NASDAQ:DTV) in a transaction worth $67.1 billion, including DirecTV’s net debt. The telecom giant will pay $95 for each share of DirecTV comprised of $28.50 per share in cash and $66.50 per share in AT&T stock. The company through this transaction expects to achieve cost savings of more than $1.6 billion annually within three years of the transaction’s close. ^[1]

While the deal will bolster AT&T’s free cash flows, the question remains why would it acquire a pay-TV operator given the saturation in the industry. As far as DirecTV is concerned, the deal makes sense as the satellite company can finally offer broadband services, which is something it has been eyeing for long. However, the regulatory approval remains a key concern, primarily due to the fact that both the companies compete in some markets.

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DirecTV Eyeing Broadband

DirecTV has posted solid results over the past few years in terms of subscriber growth and average revenue per user (ARPU), consistently outperforming most competitors. It must be noted that the growing availability of online content as an alternative video platform, along with an expanding market for connected devices, poses a competitive challenge to the entire pay-TV industry in the U.S. The cable companies in particular have been losing video subscribers for quite some time now. The pay-TV subscriptions declined for the first time in 2013 when the industry lost more than 104,000 subscribers. ^[2]

Given the saturation in the industry, pay-TV operators have been looking towards other avenues for growth. DirecTV expanded into Latin America while its rival Dish Network (NASDAQ:DISH) has amassed wireless spectrum. For cable companies such as Comcast (NASDAQ:CMCSA) and Time Warner Cable (NYSE:TWC), it was broadband that fueled the growth. However, DirecTV could not offer broadband because of speed constraints in satellite-based Internet. The deal with AT&T could provide DirecTV the broadband channel it has been looking for. It must be noted that broadband still remains an important growth engine for operators in the U.S. Currently, broadband penetration in the U.S.  is close to 75% and broadband is expected to reach more than 90% U.S. households in the long run. If we look at last year, the overall broadband industry (17 largest players representing 93% of the industry) acquired 2.6 million new broadband subscribers, taking the total subscriber base to 84.3 million. The following chart from Leichtman Research Group shows broadband subscribers and net adds among telcos and cable companies in 2013.

The broadband growth story has been similar for the past few years. It thus makes sense for a pay-TV operator like DirecTV not to be left out in the hunt. With the transaction with AT&T, DirecTV could provide broadband to 15 million customer locations, primarily in rural areas within four years of takeover. ^[1]

Regulatory Concerns

While both the companies have entered into a definitive agreement, the regulatory authorities must approve the deal. It must be noted that Comcast’s deal with Time Warner Cable hasn’t been approved yet. The Justice department’s antitrust division is likely to look into anti-competitive and neutrality issues, while the Federal Communications Commission will will review its potential impact on consumers. A merger of DirecTV and Dish Network was blocked more than a decade ago. In 2011, AT&T itself had to abandon a purchase of T-Mobile U.S. due to antitrust opposition.

Another important point in AT&T-DirecTV deal is that it would eliminate a choice for pay-TV customers in some markets because AT&T’s U-verse landline video service competes with DirecTV, which is not the case with Comcast’s acquisition of Time Warner Cable. DirecTV has 20.3 million U.S. customers, while AT&T’s U-verse TV service had about 5.7 million customers at the end of the first quarter. Given the regulatory concern, there could be a situation where AT&T would have to stop offering U-verse TV and only offer DirecTV’s satellite video service along with U-verse broadband.

This is an interesting development in the communications industry. The industry remains active with Comcast and Time Warner Cable merger waiting for regulatory approval while Dish continues to amass more spectrum. We are eager to see how events unfold from here, primarily on the regulatory front.

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1. AT&T to Acquire DIRECTV, DirecTV’s Press Release, May 18, 2014 [↩] [↩]
2. Major Multi-Channel Video Providers Lost About 105,000 Subscribers in 2013, Leichtman Research Group, Mar 14, 2014 [↩]