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AT&T Has Few Options for Its Slumping DirecTV. None Are Great

Scott Moritz

(Bloomberg) -- AT&T Inc. and activist investor Elliott Management Corp. seem to agree on one thing: DirecTV, the phone giant’s shrinking satellite service, is a drag on the company. But solving the problem won’t be easy.

AT&T acknowledges the faster-than-predicted decline at DirecTV. But Randall Stephenson, chief executive officer and architect of the company’s $48.5 billion purchase, sees the service as one of two key businesses -- the other being mobile phones -- that will allow the company to pipe entertainment and advertising to millions of customers.

The problem is that AT&T lost 2.3 million TV customers in the past year, and expects to lose up to 350,000 more this quarter, Chief Financial Officer John Stephens said at a Sept. 11 investor conference. The division, including the online streaming service DirecTV Now, is being sued for allegedly misleading investors about its subscriber numbers, and its value today is below what AT&T paid for the business four years ago.

Stephenson met with officials of Elliott Management on Tuesday, according to a person familiar with the matter. In a letter to AT&T last week, Elliott said it had acquired a $3.2 billion take in the phone company, highlighted areas for improvement and raised the possibility of divesting DirecTV.

Here are some of the options that AT&T has for DirecTV, along with the pros and cons.

Dish Deal

AT&T and Dish Network Corp. -- the other major satellite TV provider -- are suffering the steepest subscriber losses in the pay-TV industry. And in June they said they are open to a combination.

But the creation of pay-TV colossus with almost 30 million subscribers would almost certainly face regulatory opposition, even today when viewers have so many new options available, like Netflix and new streaming services from media giants including Walt Disney Co. and Comcast Corp.

“That’s been tried from a regulatory perspective,” Stephens said on Sept. 11. “It hasn’t been successful, and I don’t know that there is any change in that regulatory perspective.”

Still, the rationale of pairing two declining businesses has its fans.

“It’s complicated but not impossible,” said Jonathan Chaplin, an analyst with New Street Research. “On the right terms, it could get financing.”

There would be benefits to combining the businesses: With scale comes negotiating leverage, lower content costs and potentially lower overhead. The cash generation is attractive. And add a dynamic management team, and it could be run successfully, Chaplin said.

But there are also concerns: Depending on how a deal is structured, AT&T could lose a key distribution arm for its emerging media strategy and suffer a crippling loss of cash flow. DirecTV has $25.5 billion in annual revenue and generates about $4.5 billion in free cash flow, according to estimates by Walt Piecyk, an analyst at LightShed Partners LLC.

“Markets always believed they bought this declining asset with steady cash flows as a stop-gap measure to strengthen their balance sheet and credit metrics,” said Todd Lowenstein, managing director of Highmark Capital Management Inc.

Spinoff or Sale

AT&T could separate its TV business in a variety of other ways, including a sale to private equity investors or a spinoff to shareholders.

The proceeds of a sale could help AT&T reduce some of its $194.5 billion in total debt. That would provide the biggest boost to its credit rating, according to a report Friday from Neil Begley, a Moody’s Corp. analyst.

Similarly, AT&T could distribute stock in DirecTV to its current shareholders via an an exchange offer. That would reduce AT&T’s stock outstanding and trim its dividend burden, Begley wrote.

As part of such a transaction, DirecTV could also take on debt and pay AT&T a dividend to reduce its own borrowing and compensate for the loss of cash flow. Such an arrangement is “probably one of the more credit favorable ones after an outright sale,” Begley said.

Again, with a deal AT&T would potentially lose a customer base for its advertising and media products. And even freed of DirecTV, the company will still have a lot on its plate. AT&T faces a heavy spending burden for 5G network expansion, its dividend and further debt reduction. The company’s newly acquired WarnerMedia division is ramping up the production of movies and TV shows to support its new streaming efforts.

“A sale or spin could make some strategic and financial sense given the shifting competitive landscape, but they still need to be laser focused on execution to succeed,” Lowenstein said.

Hang On

Dallas-based AT&T knew it was buying a mature satellite TV business with a limited shelf life when it acquired DirecTV. Stephenson’s plan, given enough time, was to gradually serve customers through broadband connections, as it’s trying to do now with the new AT&T TV offer, a lower-cost cable-like service.

Those customers, along with the 77 million regular monthly wireless subscribers, would provide a big base to sell advertising and additional services, like the upcoming video streaming service HBO Max.

Making progress on those fronts is crucial. Left as is, AT&T’s TV business could see steeper declines in pay-TV subscribers. Faster revenue losses will make it tougher to meet those other cash needs.

“If AT&T can’t find an attractive exit from DirecTV, then they will continue to squeeze as much free cash flow as they can from the TV business,” Piecyk said. “If they can leverage network improvements, push back on content pricing and slow subscriber losses, it would certainly advance their strategy.”

To contact the reporter on this story: Scott Moritz in New York at smoritz6@bloomberg.net

To contact the editors responsible for this story: Nick Turner at nturner7@bloomberg.net, Rob Golum, Linus Chua

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