Telecommunications giant AT&T (NYSE:T) is struggling to find new avenues for growth. The communications industry in the United States is a saturated business, meaning there aren't many catalysts to grow the industry. One way to obtain growth is to buy it, which is the direction AT&T is about to take.
AT&T announced it will acquire pay TV provider DIRECTV (NASDAQ:DTV) in a huge transaction valued at $67.1 billion, including debt. The deal will result in immediate benefits for AT&T, including millions of subscribers, and the potential for significant cost synergies down the road.
Meanwhile, the acquisition would obviously be beneficial for DIRECTV shareholders, who will receive a sizable 32% premium above DIRECTV's share price from just one year ago.
The deal should help AT&T keep paying out its large dividend, but also underscores some fundamental challenges in attaining growth. It seems that whether AT&T is right for you depends on whether you are an income or growth investor.
Growth through acquisition
AT&T is a highly profitable company that racks up solid cash flow. It generated $8.8 billion in cash from operations in the first quarter alone. Like other telecoms, AT&T uses a lot of this cash to pay a hefty dividend to shareholders. Its dividend yield stands at 5%.
While those figures are probably attractive to risk-averse investors looking for current income, growth investors may not find a lot to like from AT&T. It racked up just 3% revenue growth in the first quarter 2014 and expects a modest 4% revenue growth this year.
Restrained growth comes from the fact that, at least in the United States, most who want cable TV or cellular phone service probably have it at this point. AT&T now will be able to expand its footprint in video by adding DIRECTV's 20 million subscribers.
It's worth noting that DIRECTV is the No. 1 satellite provider in the United States, and has a valuable asset through its NFL Sunday Ticket package. DIRECTV currently pays the National Football League $1 billion per year for the exclusive rights, which is a major advantage over other cable or satellite providers.
Still, there isn't much room left for cable or satellite TV providers to grow in the United States. In fact, companies are starting to see growth decelerate, which raises questions about this deal.
Stiff competition ahead
It's curious to see AT&T announce such a huge acquisition when pay television is intensifying via companies like Netflix and Hulu. Those two online streaming services provide subscribers with virtually all television shows, at a fraction of the cost of a traditional cable or satellite package.
This is evident in DIRECTV's slowing sales growth. It posted double-digit revenue in 2010 and 2011, but has slowed significantly since then. To that end, consider that after generating 11% revenue growth in 2010 and 12% revenue growth the following year, DIRECTV's growth slowed to 9% in 2012 and 6% last year.
The concern here is that DIRECTV is in a vulnerable position, and may not add the kind of lasting growth necessary to justify the deal. Consumers aren't displaying a great deal of loyalty to their cable and satellite providers, based on increasing dissatisfaction over claims of poor customer service and pricing.
Legitimate questions remain
DIRECTV is solidly profitable, but its slowing growth rate should be a concern that Netflix and Hulu are taking bites out of its subscriber base. Growth has decelerated for the past several years, which raises serious questions regarding the cord-cutting phenomenon taking place right now. Consumers are still pinching pennies, which means expensive cable packages are starting to look less and less appealing.
It's not hard to understand AT&T's desire to add subscribers and keep generating the necessary profits to sustain its hefty dividend payments. Buying out DIRECTV will provide instant top-line and subscriber growth and should be accretive to earnings once the deal is completed. Whether this stops the trend of consumers flocking to cheaper streaming services is another question entirely.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends DTV. 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.