Why the Deal for DIRECTV Is a Long-Term Positive for AT&T Inc.

AT&T's purchase of DIRECTV seemed to come out of nowhere, but it could be one of the best deals we've seen in a number of years.

Jun 3, 2014 at 12:00PM

AT&T (NYSE:T) appears to be that much closer to a deal to buy satellite TV provider DIRECTV (NASDAQ:DTV). The deal could be worth almost $50 billion. That is a big acquisition to integrate for company of any size. However, the positives seem to outweigh the negatives. The move will position AT&T as a leader in wireless services and pay-TV, while also giving AT&T a strong foothold in the fast-growing Latin American market. Also, don't forget that AT&T offers a dividend yield of nearly 5%. Could AT&T become an income and growth story?

A quick deal overview
The existing management of DIRECTV will continue to run the business as an operating unit of AT&T. The combination of AT&T and DIRECTV will create another giant in pay-TV of around the same size as Comcast (NASDAQ:CMCSA), if its acquisition of Time Warner Cable (NYSE:TWC) comes to fruition. The big issue is the regulatory hurdles that the deal faces.

Time Warner Cable is up only 5% since Jan. 1. Meanwhile, DIRECTV is up 21%. The thing about the Comcast-Time Warner deal is that it marries the two largest cable companies in the U.S. Unlike the AT&T and DIRECTV, deal which marries two companies in different industries.

The changing scenario in the telecom industry
AT&T's purchase of DIRECTV will combine the second-largest wireless company in the U.S. and the second-largest pay-TV operator. This will accelerate the convergence of wireless networks and video distribution.

AT&T is getting a national satellite TV presence, which will pair nicely with its wireless and broadband Internet offerings. This comes as the number of customers watching video online continues to increase. The Comcast deal likely fueled AT&T's move, where the marrying of Comcast and Time Warner will strengthen the idea of using the Internet to deliver video.

Why AT&T is making the deal
One of the main reasons AT&T is making the deal is to improve its ability to bundle services. By incorporating the pay-TV service with 20 million customers into its portfolio of telecom services, the company hopes to create a more robust bundle of services for customers. The growth of customers wanting wireless services is declining, and the rationale for the deal is to get more money from these, as well as existing customers.

Currently, AT&T has an average revenue per user, or ARPU, of around $170 per month, whereas DIRECTV generates more than $102 per month from pay-TV alone. The bundling of these services should see a significant jump in revenue. It currently has 11 million customers for U-verse, but only 5.7 million receive TV. The combined company would also have much greater advantage in negotiating prices with content providers.

The performance of DIRECTV
The numbers for the first quarter were quite good for DIRECTV, with revenue growing by 6%. The company added 361,000 subscribers in Latin America and 12,000 in the U.S. EPS for the quarter grew by 14% to $1.63 a share. Latin America remains DIRECTV's key growth avenue. Only about 20% of the total company revenue came from Latin America, but it accounted for around 95% of the company's subscriber growth last quarter. There is also a big opportunity to continue growing in the area, since only around 40% of households in Latin America subscribe to pay-TV.

Pros and cons
First, the cons: AT&T has its own TV service, and DIRECTV is not going to contribute any wireless spectrum, which would have been of value to any wireless operator. DIRECTV will be a large acquisition to digest, and this is on top of any regulatory problems that may arise.

However, one major pro would be that AT&T is almost exclusively a U.S. company, and the acquisition would add important geographical diversification by way of Latin America. Moreover, DIRECTV has an extensive satellite network with unparalleled penetration into rural or remote locations, and it would cost AT&T a lot to set up this kind of distribution. It also has exclusive distribution rights for major sporting events in golf and tennis, in addition to the NFL.

Bottom line
There are plenty of synergies in the transaction, and AT&T could be a big winner in the long term. AT&T is already one of the more attractive income stocks, with a dividend yield around 5%. In addition, the DIRECTV acquisition could help AT&T boost top-line growth. For investors looking to play the telecom industry, AT&T is worth a closer look.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends DirecTV. 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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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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