AT&T Bails on Its Hollywood – and Streaming – Dreams

By Berna Barshay

Tuesday, May 18, 2021
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► Telecom giant AT&T (T) has abandoned its vision of the future where communications and entertainment are intertwined...

Through a series of costly acquisitions, AT&T transformed itself from strictly a telecom services provider to a major media player as well.

Under former CEO Randall Stephenson, the wireless company had first scooped up satellite TV provider DirecTV and later the vast media assets of the former Time Warner, including properties such as the Warner Brothers studio, cable news network CNN, the TBS and TNT basic cable networks, and premium cable's crown jewel, HBO.

With these assets in hand, AT&T made a hard court press into the growing and increasingly competitive world of streaming subscription video through the launch of HBO Max.

While the streamer had a rocky start, it seemed to have been picking up some momentum of late. But the road to profits was surely going to be a long one, and the investment in content required to get there would be huge... and a burden on the parent company, which is sitting under a mountain of debt, the legacy of its binge of diversifying acquisitions.

Stephenson's vision was to squeeze synergies out of the marriage of distribution with content. As a big player in not only mobile but also broadband internet access – and later satellite video service – AT&T's legacy was firmly in the world of distribution. The acquisition of Time Warner married that distribution to a content behemoth, with production and library assets in a wide range of genres.

I wasn't a fan of AT&T's big, bold repositioning, nor was my colleague Enrique Abeyta...

As I have written about before, we both agreed that buying the Time Warner and DirectTV assets left AT&T overburdened by debt and in a disadvantaged place to focus on the investments it needed for its core wireless business, like the rollout of 5G.

Enrique repeatedly expressed that AT&T's massive debt load was an existential threat to the company's future existence. He often said he thought AT&T would eventually go bankrupt.

I thought it overpaid for DirecTV and bought the business too close to the top, when the writing was already on the wall about cord cutting. Satellite – unlike cable – is not an efficient or low-cost provider of broadband in most areas, so there was no second card to play for DirecTV, as there has been for cable companies like Comcast (CMCSA), which has offset what it has lost as a video provider by selling more Internet access.

The acquisition of Time Warner was a headscratcher for me and Enrique, and the successful integration of these assets was always a risk.

A year ago, AT&T brought in a talented executive (and my old Harvard Business School friend, so I admit my bias) Jason Kilar to run WarnerMedia and he made some extremely bold moves to position the entertainment assets as digital-first and customer-focused, most notably deciding to release all Warner Brothers films on HBO Max the same day they hit theaters.

The COVID-19 disruption to movie theaters appeared to be cover for moving in the direction he envisioned the industry ultimately going, but more quickly, since the decision to simultaneously release December holiday movies to homes and theaters clearly was made with limited visibility to what the state of the pandemic – and movie theater attendance – would be a year out.

The bold move upended all sorts of relationships in the industry – not only between the movie theaters and the studio, but also all sorts of relationships that impact economic interests, like back-end deals for actors, directors, and other talent. It also clearly had influence on the whole industry, as Disney (DIS) has followed suit with plans to release several big movies, including the Marvel entry Black Widow, now to its streaming service Disney+ – some with an upcharge – on the same day they hit theaters.

With the new WarnerMedia coming out swinging, it was shocking the speed with which AT&T did an about-face and decided to part with control of its entertainment assets. It was only three years ago that AT&T paid $85 billion to buy Time Warner!

Rumors of a large transaction only started to surface a few days ago, but yesterday AT&T surprised everyone with the announcement that it would be spinning off its media assets and combining them with those of Discovery (DISCA). AT&T will retain 71% interest in the new yet-to-be-named company and receive cash and bonds worth $43 billion, which should allow it to pay down some of its $180 billion in debt.

The new company, which will have a hefty $56 billion in debt, will be the second-largest media company in the world (measured by revenue) after Disney.

The deal – which was born from a text from Discovery CEO David Zaslav to AT&T CEO John Stankey while they were both watching the Pro-Am golf tournament on TV in February – led to series of secret meetings between the two execs to negotiate the details.

The new Discovery-Time Warner entity will be run by Zaslav, which means that while it will retain a financial interest, AT&T wants the day-to-day management of an entertainment business off its plate.

Why is this happening, and does it even make sense?

Last July, when Stephenson handed over the reins of AT&T after 13 years at the helm, AT&T President, COO, and longtime company veteran Stankey took over as CEO.

Changing of the guards in the C-Suite can bring these kinds of radical strategy shifts. Maybe Stankey was never fully on board with Stephenson's dream of using content to drive subscribers and loyalty for data services? But that's a dubious explanation because Stankey was a key player in getting these deals over the finish line.

Maybe the bill for making HBO Max a true streaming contender was going to be a lot higher than planned? Or maybe the bill for building out 5G is looking to be more than they expected?

Or maybe the company is finally acknowledging what Enrique and I have been screaming from the hills: AT&T has too much debt.

Whatever the motivation, the combo with Discovery makes a lot of sense... Building a streaming service is expensive, and scale matters. The quest for scale drove the combination of Disney and Fox's (FOXA) entertainment assets, and it's what's ultimately driving this deal as well.

Layer on the fact that WarnerMedia's strength is in scripted content (HBO, Warner Brothers, DC Comics) and news (CNN), while Discovery's core competencies are in reality, documentary, nature, and other unscripted content... and you are combining two companies with very complimentary assets.

Key Discovery properties include the cable networks Animal Planet, HGTV (home and garden), the Food Network, and Oprah Winfrey's OWN. The two companies together will also have a toehold in sports broadcasting through WarnerMedia's TNT and TBS networks and Discovery's international operations.

The deal makes a lot of sense... especially for Discovery, which was really too small – and niche in content – to make a great run at becoming a force in streaming on its own.

Paired with the Time Warner entertainment assets – still among the crown jewels of Hollywood in terms of library and franchises – the combined entity has a real shot of staking out a spot in the crowded streaming space.

Discovery had to find a partner to have a legitimate shot at competing with industry leader Netflix (NFLX) and Disney+, the most successful of the streaming offerings from legacy media companies. As great as the media assets are at HBO/Warner, WarnerMedia will probably benefit from more scale as well.

The strikingly swift capitulation by AT&T from the goal of vertically integrating content and distribution will have ripple effects throughout the media industry...

The about-face from AT&T calls into question if any real synergies can be gained through the vertical integration of content and distribution... which could cause analysts covering Comcast – or even the company itself – to reevaluate the cable company's ownership of NBCUniversal, which it purchased from General Electric (GE) several years ago.

While the Warner-Discovery tie up will ultimately create a stronger entry into the streaming landscape, in the short-term, the challenges of merger integration could prove disruptive and a temporary obstacle to subscriber growth.

When it gets its act together, the new Warner Discovery – or whatever it ends up being called – will be more competitive... but I don't think the folks at Netflix are losing any sleep over this...

With 208 million global subscribers, Netflix is far out in front of the pack when it comes to subscriber counts, volume of content, and globalization.

Disney probably can rest easy as well. It has amassed 104 million subscribers in just 18 months with its "must-have" content for families with children under 12. Additionally, both Star Wars and Marvel are unique franchises that pull with them large loyal swaths of subscribers.

Tech giants Amazon (AMZN) and Apple (AAPL) give away their streaming services like a "free gift with purchase" at this point, with the former using streaming as a bonus for Prime members and the latter's service coming free for a year with your iPhone or iPad purchase.

The loser here is ViacomCBS (VIAC), which was already late and struggling with its Paramount+ service. It was always going to be duking it out with HBO Max, NBCUniversal's Peacock, and Disney's Hulu to be the adult-oriented service people subscribe to, in addition to Netflix, but its competitive value proposition diminishes with this deal.

Ironically, it was both Discovery and ViacomCBS whose stocks got way ahead of themselves earlier this year on overly rosy outlooks of their streaming prospects, with a huge tailwind from the highly concentrated and leveraged positions taken by the now blown-up Archegos fund.

I didn't like VIAC shares at $100, and I didn't like them at $50. Now trading around $40, I might have warmed up to them based solely on valuation, but this deal incrementally cools me on the future prospects for Paramount+, so I would still avoid VIAC shares.

(I will admit this deal does make it more likely that some entity makes a play for ViacomCBS. It's a race to get bigger right now. It's also not impossible to imagine NBCUniversal changing hands.)

I'm not racing to buy the new "old AT&T," either...

Even paring down debt with this transaction, I still think AT&T is overleveraged.

And while Stankey may be doing the right thing here by cutting the cord on a bad deal, he was very much in the room where it happened.

Stankey's responsibilities before becoming CEO included being AT&T's chief merger strategist... so I don't absolve him of responsibility for the Time Warner deal that went south. Let's also not forget about the debacle with DirectTV that he was an architect of – the one in which AT&T paid $49 billion for the asset in 2015 then sold 30% of it recently to private equity firm TPG at a $16 billion valuation.

So I still have my reservations about AT&T leadership... AT&T is another stock to avoid.

I need to see how the new combined Warner Discovery ultimately ends up valued... but this deal feels like a bit of a double down into the rapidly deteriorating landscape of traditional cable TV.

If the combined entity can funnel the cash flows from those legacy networks to build a global streaming player fast like Disney did, then it could be interesting.

But it is a race against the clock to build that streaming business to profitability, given the recent acceleration in cord cutting.

The New Co. is a "wait and see" for me... The only thing I am sure about is that I do like these two companies better together than separate.

In the mailbag, a long letter with some interesting observations from reader and prolific letter-writer, Seth...

Any HBO Max fans out there? How about big users of Discovery's streaming service, which I haven't tried yet? Did the AT&T-Time Warner deal ever make sense to you? Does the rationale for this tie up make more sense? Share your thoughts in an e-mail to [email protected].

"Dear Berna: I think I have the missing link in your analysis on the jobs report, and I encourage you to take a walk with thoughts as I piece together a complicated hypothesis (that, however, makes a tremendous amount of sense despite the dearth of data).

"As an economist in training, it's critical to say that payroll data is the specific metric used to classify employment.

"With that said, I need to draw attention to the graph you provided regarding the working population. It's been declining since the inception of the dot com boom. Specifically, I am thinking of a few vital players: Facebook (FB), Google (GOOGL), Microsoft (MSFT), and Amazon, who owns Twitch streaming, but predominantly those four (and for my theory, I'll throw in TikTok, you'll see where I'm going with this shortly). You can or cannot regard the recessions and booms; frankly, they're irrelevant as the trend is still downwards since the inception of this new economy around 2003.

  • Google employs 135,301 people (on their payroll)
  • Amazon employs 1,200,00 people (on their payroll)
  • Facebook employs 50,000 people (on their payroll)
  • Microsoft employs 160,000 people (on their payroll)

"All according to macrotrends.net

"Together, 1,545,301 people are employed by these companies, an impressive metric for just four companies.

"However, this is the grossest misrepresentation I have ever seen. Those companies and their subsidiary companies (Instagram, Twitch, and YouTube just to name a few) employ together millions of more people in a different classification, 'creators.'

"According to this Forbes article, there are over 50 million creators in this economy. They are all employed by these tech giants, just in a way that pervades economists' data sets.

"To tie it back to payroll data, these people aren't on the payroll of these companies. They skip the payroll classification economists use. At the same time, these people run businesses (to shelter income), and depending on the firm's size, they may or may not pay a payroll tax (it all depends on the size of deductions you want to take out now and if those numbers make sense). And if they do, the government doesn't classify their source as an 'Instagram influencer' or 'Mr. Beast's YouTube Channel,' those figures are reported under that corporation's name, while the source of the waterfall is YouTube, which pays Mr. Beast.

"Considering newer applications/companies like Clubhouse and TikTok, the accounting problem is only growing in size.

"TikTok now employs many people through their creator economy as does OnlyFans and Instagram. Economists fail to capture this because many of these individuals don't pay a payroll tax; They pay an income tax. (This is even assuming all creators are tax-efficient, many I assume cannot/don't hire accountants like my father, who to use a kinder term, 'plans taxes' for generationally wealthy people and trust fund folks (you know the type)).

"With websites like The Information (fantastic online newspaper, highly recommended despite their expensive subscription) regularly reporting on the growth of the new creator economy industry and how venture capital is now starting to become involved, I anticipate this gap to grow.

"If we were to modify the data set captured to include this new economy – 'the creator economy' – I have a sneaking suspicion the economic picture captured would look very, very, very different — pandemic or not.

"All the best" – Seth R.

Berna comment: Interesting thoughts, Seth. I have no idea the magnitude of how much the creator economy is suppressing the employment numbers... but I agree this aspect of the gig economy is growing like a weed.

Regards,

Berna Barshay
May 18, 2021

Whitney Tilson

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About Berna

Berna Barshay is editor of Empire Financial Daily and a contributing editor to the Empire Stock Investor and Empire Investment Report newsletters.

She graduated cum laude from Princeton University and earned her MBA from Harvard Business School in 1997.

Following her graduation, Barshay spent 20 years on Wall Street. She began her career in equity derivatives at Goldman Sachs and later worked as a buy-side equity analyst at Sanford Bernstein, where she covered global consumer cyclicals and conglomerates.

Later, Barshay spent five years working as a portfolio manager of the Ingleside Select Fund, a long/short fund with a focus on value and event-driven stocks. She later was a portfolio manager at Swiss Re, where she managed the Consumer long/short book on the equity proprietary trading desk.

She has additional experience as a buy-side analyst at several long/short hedge funds – including Sky Zone Capital, Metropolitan Capital, Buckingham Capital, and LaGrange Capital – where she primarily covered consumer and technology, media, and Internet stocks in the U.S. and Europe, with some additional work in financials and energy.

Barshay is a fashion enthusiast, a pop culture addict, obsessive indoor cycler, and prolific social media user. She currently lives in New York with her husband, daughter, and three dogs.