Media and telecom do not mix

Media companies are aggregating content via M&A to create more formidable competitors in fast-growing direct-to-consumer streaming services, while telecommunication companies are investing heavily to strengthen wireless technology and high-speed internet access. However, the convergence of telecom and media assets due to changing media consumption patterns and alternative distribution platforms is no longer a strategic focus for some telecom companies and those that acquired media assets are divesting them.

A grand experiment by US wireless carriers to make and distribute video content appears to be coming to an end. Just 3 years after it fought the Justice Department to complete its USD 85 billion purchase of media giant Time Warner, AT&T is selling off its entertainment business to drill back down on the basics and specifically on 5G.

AT&T recently unveiled the change in strategy by announcing a USD 43 billion deal to sell its WarnerMedia assets to Discovery. The deal marks a drastic change in direction for AT&T, which poured its resources into convincing the government to let it buy Time Warner with the goal of creating a behemoth that owned both the content and the pipes that connect to consumers.

That turned out to be a strategic error, saddling the company with debt at a time when it also needed to inject capital both into its HBO Max streaming service and into its 5G network to keep up with T-Mobile and Verizon Wireless. With competing obligations, something had to give. So, AT&T executives are going back to what they know well.

AT&T and Discovery Communications have reached a definitive agreement to combine AT&T’s WarnerMedia with Discovery, creating what they called a TV and streaming giant. The new company would aim to take on the leaders in the new streaming TV market, now led by Netflix and The Walt Disney Co.

Warner Bros. Discovery is the result of AT&T spinning off WarnerMedia, which owns a variety of major media properties including CNN, TBS, TNT, Warner Bros. film and television studio and HBO. That company is merging with Discovery, which owns Discovery Channel, Animal Planet, TLC, the Food Network and various other media properties.

AT&T, which bought Time Warner 3 years ago for USD 85 billion, will receive USD 43 billion worth of cash and debt. Its shareholders will own 71 percent of the new company. The deal would unwind AT&T’s strategy of combining its mobile phone and broadband assets with a content company.

This is the second spin-off the phone giant has made in about 3 months. In March, it spun off DirecTV in a separate, publicly traded unit that would include private equity giant TPG, for about USD 16 billion, or less than half the USD 49 billion (USD 66 billion including debt) it paid for the asset in 2015. In December 2020, the telco hived off its anime video unit, Crunchyroll to a unit of Sony Corp. for USD 1.2 billion. The company has parted with its Puerto Rico phone operations, a stake in Hulu, a central European media group and almost all its offices at New York’s Hudson Yards.

Discovery’s CEO David Zaslav will be the head of the combined company, which will own streaming assets in HBO Max and Discovery Plus and a collection of cable networks, including the former Turner networks’ news channel, CNN, general entertainment and sports channels TBS and TNT, and kids’ programmer Cartoon Network as well Discovery’s unscripted channels HGTV, Food Network, Discovery, TLC, and OWN.

The combined company is projected to have 2023 revenue of USD 52 billion and adjusted EBITDA of USD 14 billion. The combination of the two companies is expected to result in USD 3 billion cost synergies annually. They spend a total of USD 20 billion on content, more than Netflix, which plans to spend USD 17 billion this year.

“This agreement unites two entertainment leaders with complementary content strengths and positions the new company to be one of the leading global direct-to-consumer streaming platforms. It will support the fantastic growth and international launch of HBO Max with Discovery’s global footprint and create efficiencies which can be re-invested in producing greater content to give consumers what they want. For AT&T shareholders, this is an opportunity to unlock value and be one of the best capitalized broadband companies, focused on investing in 5G and fiber to meet substantial, long-term demand for connectivity. AT&T shareholders will retain their stake in our leading communications company that comes with an attractive dividend. Plus, they will get a stake in the new company, a global media leader that can build one of the top streaming platforms in the world.”

John Stankey, CEO, AT&T Inc.
“During my many conversations with John, we always come back to the same simple and powerful strategic principle:  these assets are better and more valuable together.  It is super exciting to combine such historic brands, world class journalism and iconic franchises under one roof and unlock so much value and opportunity.  With a library of cherished IP, dynamite management teams and global expertise in every market in the world, we believe everyone wins…consumers with more diverse choices, talent and storytellers with more resources and compelling pathways to larger audiences, and shareholders with a globally scaled growth company committed to a strong balance sheet that is better positioned to compete with the world’s largest streamers.  We will build a new chapter together with the creative and talented WarnerMedia team and these incredible assets built on a nearly 100-year legacy of the most wonderful storytelling in the world.  That will be our singular mission: to focus on telling the most amazing stories and have a ton of fun doing it.”

David Zaslav, Chief Executive Officer, Discovery Inc.

What the merger means for the media industry. It is almost taken for granted that telcos are not good managers of media assets. Certainly, there seems to have been a big mis-step made by AT&T in regards to who it hired to manage the transition of WarnerMedia from its traditional way of doing business where strict P&L silos separated the film, pay TV and free TV businesses, into the world of streaming services.

A tech-minded, media outsider, WarnerMedia’s outgoing CEO Jason Kilar was brought in by AT&T CEO John Stankey only 10 months ago to shake things up. There is a certain amount of schadenfreude in the fact that the man who took a hatchet to the traditional Warner Media structure including cutting many long time, senior executives, is now negotiating his own exit from the company.

Perhaps Kilar’s audacious decision last year to throw out the century-old theatrical distribution model was part of the whiplash that is seeing him head for the door. In December last year, Kilar announced that the entire 2021 Warner Bros film slate of 17 films would be released simultaneously in cinemas and on the HBOMax streaming service.

While Disney had decided on a similar simultaneous release for its fantasy action-drama Mulan, the difference was that Disney+ subscribers had to pay an extra USD 30 for the privilege. Kilar decided that no surcharge would be applicable for Warner Bros films, starting with Wonder Woman 1984 which became available to HBOMax subscribers for no extra charge on Christmas day 2020. At the time, one analyst said the decision would lose Warner Bros as much as USD 1.2 billion in global box office revenue.

As the move to DTC services continues, the stakes could not be higher for legacy media companies and advertisers, too. The pivot to streaming video services by audiences is taking its toll on linear channel ratings and the move by broadcasters to their own VoD services is a work in progress.

The pressure is mounting as the big legacy media players continue to adding free, ad-supported VoD (AVoD) services to their streaming offers. The latest is HBOMax, which announced a USD 10-a-month AVoD tier on May 19, only days after the WarnerMedia/Discovery announcement. The new ad-tier will include much of WarnerMedia’s content library but significantly users will not have access to the Warner Bros’ same-day premiere films.

Netflix and Disney+, with 208 million and 104 million subscribers respectively, are the kings of the SVoD streamers. The rest of the pack, including AT&T’s HBOMax at 44 million subscribers, NBCUniversal’s Peacock service at 42 million subscribers, and Discovery+ at 15 million are all playing catch up. The combination of HBOMax/Discovery+ puts the newco at 59 million subscribers and if Zaslav has his way the combination of programming and brand assets will spur faster growth.

But the rest of the industry is not standing still. AT&T’s CEO John Stankey told reporters and analysts when the deal was announced that he expects there will be more consolidation to come. “We… (wanted to) initiate that rather than have to follow it,” he said.

There is still much to be done to make sure Warner Bros. Discovery resonates with customers enough to both attract their attention and a share of their wallet.

The strategy shift comes as both the media and wireless landscapes have gotten more competitive. Over the past few years, viewers have been shifting away from traditional pay TV services to streaming platforms, like Amazon and Netflix. The competition for viewership has gotten intense, especially as new entrants like Disney Plus have come on the scene.

On the wireless side, T-Mobile’s acquisition of Sprint last year has put intense competitive pressure on AT&T. The combined T-Mobile and Sprint has overtaken AT&T as the second-largest wireless company in the US by subscribers behind Verizon. Now all three wireless giants – Verizon, T-Mobile, and AT&T – are racing to deploy 5G wireless service to a broader swath of Americans.

AT&T has lagged behind its wireless rivals in deploying valuable mid-band spectrum, which the wireless industry views as a key technology for offering faster 5G performance. Mid-band spectrum, like spectrum in the C-band offers a good mix of capability that complements low-band spectrum, which features greater reach, and ultra-high-band spectrum, which transmits over very short distances at super high speeds.

Seeing a big telco fail to grasp how to manage and invest in a content company is not new. Verizon Communications agreed to sell Yahoo and its other media assets to Apollo Global Management for USD 5 billion on May 3, 2021 so the telco could focus on its core network business and 5G rollout. The sale is another dramatic U-turn for the wireless company that between 2015 and 2017 spent nearly USD 9 billion to acquire Yahoo and AOL to anchor an online media division. Buying high and selling low is not a good business strategy, but Verizon bit the bullet as it needs to turn its financial and operational focus on the parts of its business that are key to its role as a provider of connectivity and which require a great deal of capital investment.

Clearly, Apollo thinks it can apply the transformative magic that Verizon has been unable to muster since it brought AOL in 2015 for USD 4.4 billion and then Yahoo in 2017 for USD 4.48 billion.

Other operators face similar decisions, UK incumbent BT, which is now seeking external investments in its TV operation, is just one example. BT put its BT Sport business under strategic review and interested buyers or partners reportedly include DAZN, Amazon Prime, ITV and Disney. Not only is the business of acquiring live sport rights expensive and out of BT’s core area of business but the original idea of using a live sport offer to compete with Sky for subscribers largely disappeared once the UK regulator decreed that English Premier League football should be accessible to viewers without having to pay for two separate services.

In hindsight. When AT&T first announced the deal to acquire Time Warner in 2016, then AT&T CEO Randall Stephenson called the two companies a perfect match.
AT&T argued that the deal would be a win for consumers because it would help drive down the cost of content. But then-President Donald Trump’s Justice Department was not keen on the deal, and the Justice Department sued to stop the merger. Many industry watchers suspected the Justice Department’s decision to pursue the legal case to stop the deal had more to do with Trump wanting to get back at news network CNN than concerns over antitrust. Ultimately, the government lost its antitrust case against AT&T, and the companies finally merged in June 2018.

Ultimately, the deal adds another ding to the legacy of Stephenson, who also attempted to acquire T-Mobile in a deal that was rejected by regulators. Some on Wall Street said AT&T’s strategy to diversify its business was always flawed, part of a broader misguided push by telcos to get into media.

Every time the cicadas come out to play, the telephone companies decide it is time to either get into or get out of the media business, as per said Craig Moffett, an equities analyst with MoffettNathanson. It never works, because it was never a good idea in the first place.

AT&T made matters worse by overpaying for Time Warner, which wrecked the company’s balance sheet by taking on too much debt. By contrast, when Comcast bought NBC Universal in 2011, the valuation was at a low point and the deal came at the end of a recession. Comcast has done a better job operating NBC Universal, too.  But that is not the same as validating the strategy. There have not been any real synergies between the cable and media businesses, even at Comcast.

The company’s video business has served its purpose as an aggregation point for additional offerings to consumers. But wireless and fixed broadband is anticipated as being natural, logical places for aggregation of services and extending value to the consumer, moving forward.

No matter how AT&T tries to spin this about-face, there is no doubt it is a damaging setback, not just for the telco, but also for the other big boy US telcos that all bought into the notion that content ownership was an essential ingredient if they were all to find profitable growth beyond mere connectivity. Hence, AT&T’s spin off is a failure that is bound to be food for thought for other telcos with digital media aspirations.

One lesson phone companies seemingly have to learn year after year after year is that the TV business is not the phone business. And a climate where Disney Plus has more than 100 million subscribers but still took it on the chin for not growing fast enough, just shows that streaming, as it is currently modeled, requires an unprecedented level of scale and engagement. The US telcos’ media adventures look to be coming to an end, an end of an era for so-called vertical integration – owning media and the means to distribute it.

The merger changes everything for streaming. The decision by AT&T to spin off and merge its WarnerMedia unit with rival Discovery took many in the industry by surprise. Yet, the creation of the second-largest media company in the world by revenue after Disney, is strategically unsurprising. In the global streaming race, the only way to compete is to be big. Scale is the name of the game.

Warner Bros. Discovery will vie with Netflix, Disney, Amazon, NBCUniversal, CBS and many more media companies that have invested heavily in streaming services. NBCUniversal is the parent company of NBC News. The deal has also sparked intrigue in the media industry for what it could mean about the leadership of the companies going forward.

With HBO Max, the company’s DTC offer, gaining momentum in the USA, a pure-play media company will help the market value the business more easily than when it was buried inside the much larger AT&T. The combination with Discovery+ will make the new, combined streaming service a much broader SVoD platform for in the US and around the world. WarnerMedia could also benefit from Discovery’s international cable networks and (this could) help accelerate HBO Max’s international rollout.

The impact of a combined WarnerMedia/Discovery in the UK, Germany, and Italy will, however, be somewhat different. Unlike in the US, Canada, and the Nordics, where HBO has built a standalone brand presence, in the three countries where Sky has a presence there are existing content distribution agreements that are thought to continue until 2024-25. HBO content is part of the Sky Atlantic channel in the UK, for example.

The big question for the new WarnerMedia/Discovery is what does it do now in these countries and what does it do after 2024-5? It is unlikely that the new combined company will pay the penalty to get out of those existing content distribution agreements. But might the new company offer a slimmed down HBOMax/Discovery+ SVoD offer in the Sky territories? Perhaps but that also might undermine the very brand power the combination is hoping to achieve in three key European markets.

The new combined streamer will also have an impact on companies like ITV Studios and BBC Studios, both of which sell content to Discovery and to WarnerMedia. Suddenly there are no longer two buyers but one. The consolidation of the buying points will have a knock-on effect to the studio model, such that it is in the UK.

Broadcasters are already feeling the brunt of having their principal content suppliers favoring their DTC services. There is bulking up happening there too, most recently with the announcement that in France, RTL-controlled M6 will merge with rival commercial broadcaster TF1.

With hindsight, the media and telecom industry, and clearly the executives at AT&T, can see this was a bad idea. But for the mere consumer, the announcement that the company will spin off its content arm and form a new media company with Discovery marks a pretty fortunate reversal: The company that emerges once the WarnerMedia-Discovery deal closes in 2022 will have a vast and compelling catalog that could not only compete with Netflix and Disney, but beat them.

Just look at this chart of brands under the new company’s umbrella: There’s the prestige highbrow of HBO; the blockbuster film franchises of Warner Bros. and DC; the cultural niches of Cartoon Network, Adult Swim, and Cinemax; the undisputed leader in broadcast news in CNN; sports and comedy on TBS and TNT; and—most dangerously for this new company’s rivals—a plethora of unscripted and reality content with the likes of HGTV, the Food Network, TLC, the Oprah Winfrey Network, Animal Planet, and, of course, the Discovery Channel.

On the other hand, Netflix has made strides in reality television but lacks sports. Disney covers kids with animation—and even has Hulu and ESPN+ in its empire—but is short on reality series. Amazon is establishing itself as a respectable film and television distributor but does not do news. This new conglomerate, meanwhile, says it has “one of the deepest libraries in the world with nearly 200,000 hours of iconic programming” featuring more than 100 brands.

Warner Bros. Discovery, which will be helmed by current Discovery Inc. CEO David Zaslav, says it wants to further invest in content—about USD 20 billion worth a year. That could cause the price for whatever streaming service it rolls out to rise—but will it matter if consumers feel like they do not have to pay for several different streaming services, and instead can access a cornucopia of content from just one provider?

The question remains what exactly that streaming service will be. HBO Max is not going away quite yet and is still going forward with plans to launch a cheaper, ad-supported version of the platform later this year. Discovery, meanwhile, has its own service, Discovery+, which houses the aforementioned unscripted content. But it is clear Zaslav sees the company’s strategy as combining forces. He has not ruled out merging Discovery+ and HBO Max into a giant streaming service. Or, the two might exist separately, but bundled together—sort of like what Disney+ does with Hulu and ESPN+. Either way, the new company’s brands will exist symbiotically.

Are Netflix, Disney, Amazon, and Co. powerless to compete against this new media giant? Not at all. They have the advantage of existing first. Despite ceding ground to an upstart Disney+, Netflix by far has the most subscribers out of any streaming service; Disney is the biggest media company in the world; Amazon is one of the biggest companies in the world, period. But any company that can offer consumers access to a plethora of the most riveting content lineup, it so much more will be a serious threat to those existing services—and of serious interest to viewers.

Rival studios are scrambling to get bigger. Bankers are already starting to salivate over what other megadeals could be in the offing following this week’s surprise pair-up of WarnerMedia and Discovery.
AT&T’s desperation to drop a company that it spent USD 85.4 billion and a year and half in legal fights to acquire raises the immediate question of what else might be possible in an era when Wall Street is pressuring big media conglomerates to keep generating content for audiences hungry to stream their favorite dramas and comedies.

Sure, smaller entertainment companies like Lionsgate and AMC Networks have long been seen as potential acquisition targets — and Amazon just bought MGM for its vast library for USD 8.45 billion — but financial minds are starting to indulge their greatest scenarios. What if Apple swooped in and picked up a big media name? Do NBCUniversal and ViacomCBS need to add more heft even though they are both products of sizable mergers?

“We believe that NBC Universal and ViacomCBS are now at an even greater disadvantage in the sector, as they are stuck in no-man’s land without the domestic scale and international roadmap to keep up with the now – Big Four streaming companies,” said Michael Nathanson, a media-industry analyst.

More activity seems probable. Comcast is said to have at least explored the idea of pairing up with WarnerMedia at some point in the recent past, according to people familiar with the matter. It is not inconceivable that the cable giant would jump into the fray and make a competing bid for WarnerMedia, some insiders are speculating. Comcast declined to make executives available for comment.

One thing seems clear: No one can ignore any potential step for growth. Netflix is so far ahead of the game and so far ahead on the spending that it is like the anchor tenant, according to Schuyler Moore, entertainment industry lawyer, Greenberg Glusker. All the rest are add-ons. The problem is that most customers only want to buy a second or a third premium channel.

Analysts’ take
“It is a pretty big change of direction on a pretty quick turnaround timeframe. That said, I think it makes sense. Verizon’s similar announcement earlier this month that it would sell off the AOL Inc. and Yahoo! brands under its Verizon Media Business as further indication of the challenges telcos face in achieving success in both the wireless and content realms. To that end, AT&T’s decision is not surprising directionally, but maybe timing-wise.”

Rich Karpinski, Analyst, 451 Research
“AT&T’s balance sheet was wrecked by overpaying first for DirecTV, and then for Time Warner, over a span of just 3 years. The lesson of AT&T goes beyond the company overpaying, it suffered a strategic failure as well. They were never able to articulate a clear logic for why they wanted to invest in a legacy media business that they themselves argued was about to enter a permanent secular decline.”

Craig Moffett, Analyst, MoffettNathanson LLC.
“On the streaming side, WarnerMedia has no presence in India, whereas Discovery+ is a small OTT offering in terms of genre, reach, and content. The only impact will be if Discovery+ and HBO Max come together in India and bundle their offering. Otherwise, Discovery is too small to impact the overall OTT space. On the linear business, it is unlikely to have an impact because they hardly have a major presence in India. The genres that these two networks operate in are niche in the Indian market.”
Karan Taurani, Vice President, Elara Capital