Did AT&T Just Hand Google a Gift in the Form of DirecTV?

While AT&T investors praise the benefits of a DirecTV acquisition, Google might be the biggest beneficiary.

May 20, 2014 at 1:30PM

AT&T's (NYSE:T) acquisition of DirecTV (NASDAQ:DTV) was a curve ball, as it seemingly sways from AT&T's goal of bolstering its broadband Internet to better compete against the rise of Google (NASDAQ:GOOG) (NASDAQ:GOOGL). Nonetheless, looking beyond the acquisition's lack of broadband appeal, do the benefits of DirecTV outweigh the concerns? Or, did AT&T just hand Google a massive gift?

AT&T and DirecTV: What's the point?
AT&T has confirmed that it's paying more than twice its 2014 capital expenditure budget to purchase digital television leader DirecTV for $49 billion. As a result, AT&T will gain DirecTV's 20 million U.S. subscribers and 18 million Latin American subs.

To many investors, this acquisition seems strange and far left-field from AT&T's ongoing strategy. DirecTV lacks substantial spectrum assets and has limited, if any, broadband Internet patents or services to benefit AT&T.

However, what DirecTV gives AT&T is strength in video, and completes a vision where subscribers can view TV anywhere using DirecTV's services on AT&T's massive network, which could be valuable in attracting subscribers following increased pricing pressure.

Is DirecTV's lack of spectrum and broadband a substantial concern?
The fact that DirecTV lacks spectrum may not be a big deal, as AT&T can still acquire low-frequency spectrum at next year's auction. But, what's substantial is that its $49 billion cost does not give AT&T an advantage in broadband Internet. This is a highly competitive space, one where AT&T's U-Verse GigaPower has become the company's most significant growth driver.

U-Verse finished 2013 with 10.7 million customers, growing at 25% and accounting for nearly 10% of the company's $128.7 billion in revenue. AT&T's GigaPower was recently upgraded to reach speeds up to 300 megabits per second, or 30 times faster than typical broadband.

However, this upgrade was in response to the success of Google's new initiative, called Fiber, which allows for Internet speeds of up to 1 gigabit per second, or 100 times faster than normal broadband. This is a project that analysts originally estimated could cost Google $20 billion-$28 billion over five to 10 years, but would make it head-and-shoulders above all others within the space, including AT&T's fast-growing segment.

Since the original analysis, Google has been able to cut costs by requiring customers to sign up for service prior to Fiber being built. This was successful in Kansas City and Austin, and now the company has plans to penetrate 34 new cities with the same approach.

Moreover, the company has been able to save on even more costs by using the existing infrastructure of companies like AT&T, mainly telephone poles. Due to this success, rumors have circulated that Google has plans to become a wireless provider of not only Internet, but also TV and mobile as a virtual network operator, meaning Google would essentially borrow another network. Overall, this is horrible news for competitors like AT&T, as could grow Google into the next telecom giant.

Final thoughts
In response to the news from Google, AT&T has been investing heavily into boosting its speeds to 1 Gbps, which costs large amounts of money, but is important for AT&T to maintain its position in this space. Since AT&T needs to build this network rapidly, but just spent $49 billion on DirecTV, while also paying out more than 50% of earnings in dividends and buybacks, it's easy to see that AT&T's money is running low.

With that said, cost synergies of AT&T and DirecTV are expected to total $1.6 billion, and the combined companies will seek to increase their presence in Latin America. Hence, there are benefits, but with broadband being so important, and the rise of Google Fiber being so evident, it appears that AT&T just handed Google a huge gift in the form of an acquisition, limiting AT&T's ability to focus on GigaPower. Therefore, as it appears today, it's hard to view this acquisition as beneficial when it results in neglect of what may be the most important segment of AT&T's business.

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Brian Nichols has no position in any stocks mentioned. The Motley Fool recommends DirecTV and Google (C shares). The Motley Fool owns shares of Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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