AT&T Inc. (NYSE:N:T) understands, like most already people do, that you cannot brew the same formula forever. The company has been a wireline business, has seen the rise of wireless systems and is currently witnessing how the combination of wireless and Internet is disrupting the communications sector.
History teaches that to stay relevant in the communications industry, you must not rest on your laurels. With this wisdom in mind, AT&T is trying to transform itself – repositioning its subscriber base, revamping its video play and expanding abroad. However, the major question at this point is whether AT&T is getting anywhere with its various turnaround efforts.
This AT&T analysis article puts into perspective the various efforts the carrier is making to reinvent itself and their possible outcomes.
Impact Of DirecTV Acquisition On Cash Flow
There are multiple ways in which AT&T could benefit from its acquisition of paid-TV provider DirecTV. One key way in which DirecTV will be immediately beneficial to AT&T is by boosting the carrier’s cash flow. Being an already profitable business, DirecTV could improve AT&T’s cash position by an additional $3.5 billion.
The expected $2.5 billion in cost synergies by 2018 from the acquisition of DirecTV could also bolster AT&T’s cash flow position. Therefore, taking into account DirecTV’s cash flow contribution, AT&T’s total free cash flow could rise to more than $16 billion by next year, considering that the carrier on its own had $10 billion of free cash flow last year.
AT&T needs to strengthen its cash position to support its ongoing revenue expansion and diversification efforts that include deep video involvement and expansion in Mexico.
AT&T Acquiring An Old Asset But With Eye On New Future
AT&T is acquiring DirecTV when it is fully aware of the transformation sweeping through the video market. An increasing number of paid-TV providers are moving to cut the cord in favor of Internet-based video services. It may concern many investors why AT&T is pouring $49 billion in a business that will soon be overtaken by events.
However, while AT&T understands the dynamics of the video market and the flow to online, the company is betting on the slow death of the traditional paid-TV business. It believes that as much as the rise of over-the-top (OTT) video services will choke the life out of traditional television services someday, the process will be slow and happen over many years.
AT&T’s Online Video Agenda Is Alive
As much as AT&T appears to be siding with a linear television provider at a time of transition, it is not lost on the company where the future of video consumption is moving. However, for the time that most people will still continue to consume video through linear channels, AT&T believes it will have extra value from DirecTV that it can invest elsewhere, especially in building a more robust online video service.
AT&T also understands that it is not enough just to render video over the Internet wirelessly, but owning content is an important part of the game. As such, the company is reportedly investing in online video content through its joint venture called Otter Media.
Therefore, relying on the video experience it is building, together with its vast wireless resources, AT&T is looking forward to a bright future in the video business.
Subscriber Base Repositioning
Part of T’s remaking involves subscriber base repositioning. The company is more interested in growing its postpaid smartphone subscriber numbers. That explains why AT&T has, in recent times, sought to pay less attention to winning over feature phone subscribers. As such, the population of feature phone customers on AT&T’s network has been on the decline, and the company is not feeling pain about it.
The reason AT&T is not feeling the pain of losing feature phone customers is that the group exhibits a higher churn rate and their loyalty is mostly predicated on aggressive pricing and promotions.
AT&T’s subscriber quality approach is sensible in that the company is limiting the cost of attracting and retaining low-value subscribers. The strategy should enable the company to lower its operating costs and also optimize capital allocation for better returns.
The repositioning of the subscriber base is already having a positive impact on AT&T’s average revenue per user (ARPU). The company reported that its postpaid ARPU rose by about 6% in just one year, to $68 from $64 as it increased focus on high-value customers while letting go of feature phone subscribers.
In terms of subscriber distribution, AT&T has seen its smartphone subscriber numbers lift as its feature phone customers decline. The company reported that the population of its smartphone customers rose to 65 million in the last quarter (2Q2015) from 58 million in the same period a year earlier. At the same time, the population of feature phone subscribers contracted to 9 million from 13 million in the prior year.
The chart below shows AT&T’s smartphone and feature phone subscriber trends.
Cricket Is AT&T’s Attack Dog
AT&T has clearly outlined its subscriber growth strategy, indicating that it is more interested in widening the population of its high-value postpaid smartphone subscribers. However, the company is also keen to attract and retain high-end prepaid subscribers. As such, AT&T has Cricket to serve its interest in the prepaid market. The company has at least two strategies with Cricket. It is being offered as a fallback plan for customers who do not qualify for postpaid subscription. In more recent times, AT&T has seemed to position Cricket as the attack dog against its rivals T-Mobile US Inc. (NYSE:TMUS) and Sprint Corp. (NYSE:S). AT&T appears to be particularly interested in using Cricket to raid the prepaid subscriber bases of T-Mobile’s MetroPCS and Sprint’s Boost.
Revenue Boost On Top Of Cost Synergy
AT&T is already known as one of the cost-leaders in the U.S. phone operator business and the acquisition of DirecTV is expected to bolster its cost curtailment advantages.
While cost benefit was the main theme around the acquisition of DirecTV, it should not be lost on investors that DirecTV will also bolster AT&T’s topline. DirecTV generated $33.3 billion in revenue in 2014. One of the areas in which AT&T could unlock more revenue growth from DirecTV is through upselling its subscribers, and there is wide room to do that.
Potential Pain Points For AT&T
Content Agreements
One area in which AT&T is focusing to cut cost through DirecTV acquisition is through content agreements. Because of its expanded scale, AT&T is hoping that it can pressure content providers into making favorable price adjustments. However, given that wireless and satellite content deals are usually negotiated separately, AT&T could find it more challenging than it expected to push content providers to agree to its terms.
Threat Of OTT
AT&T is betting that the disruptive machine of OTT will grind gradually, allowing it time to recoup profit and investment in DirecTV. However, AT&T has no control over how OTT penetration accelerates, which means that its assumptions could be wrong and costly at the end of the day.
Expansion Into Mexico
Sensing market saturation in the U.S., AT&T is looking abroad to unlock new growth. The company has acquired two wireless assets in Mexico to expand its footprint in the market. While the Mexico acquisition moves are sensible, it will take time before they pay off. In the meantime, AT&T could face higher cash burn than it anticipated in sustaining the new businesses in Mexico.
Bottom Line
AT&T’s transformation is in progress. There will be speed bumps along the way as already highlighted, but they won’t be life-threatening.