The Real Reason AT&T is Acquiring DIRECTV

Aside from simply adding millions of new customers, AT&T is counting on bundling services as a key motive behind its huge acquisition of DIRECTV.

Jul 23, 2014 at 2:00PM

By now, you've probably heard that telecommunications giant AT&T (NYSE:T) is about to acquire DIRECTV (NASDAQ:DTV), the largest satellite television provider in the United States. It's a huge deal valued at $67.1 billion, including DIRECTV's debt.

It's the latest move in a wave of industry consolidation in the telecommunications sector. As competition heats up and customers slowly adopt the "cord-cutting" mentality, major telecom companies are in a bind to keep producing growth.

But, aside from simply adding new customers, AT&T has broader ambitions at play. Following are AT&T's true motives for pursuing the merger with DIRECTV.

What AT&T is really after
On the surface, it seems that AT&T's ambitions are fairly straightforward; you might think that the acquisition is a simple expansion into a new market and new service. With DIRECTV and its 11 million Latin American subscribers in tow, AT&T is accomplishing dual goals of diversifying both its products and its geographic foothold. DIRECTV is the biggest satellite provider, a contrary service to AT&T's existing cable offering. In addition, DIRECTV gives AT&T meaningful presence in higher-growth markets.

But really, it's all about revenue per user. Bundling is the name of the game for cable and Internet providers, and AT&T is hoping its much larger customer base will allow for better bundled packages that pry more cash from subscribers. AT&T boasts its high-margin U-Verse service, where average revenue per user for its triple-play customers exceeds $170 per month. The triple play is a bundle in which AT&T offers a landline phone, cable television, and broadband Internet.

But, AT&T is lacking in television. It holds 11 million high-speed Internet customers, but just 5.7 million U-Verse TV customers. That's where DIRECTV comes into play. DIRECTV is the second-largest pay-television provider behind Comcast. It holds a unique advantage in TV, highlighted by its prized NFL Sunday Ticket package, a highly valuable asset.

AT&T will now have the opportunity to boost its lagging performance in television. The company's U-Verse television service is only available in 22 states, so with DIRECTV, it can fold the satellite service into its existing portfolio in those areas to complete its desire for the high margin, triple-play bundle.

Measures to fortify the dividend
In the meantime, you might think AT&T will be hard-pressed to support its high dividend, considering it plans $20 billion in capital expenditures this year, on top of the $67 billion merger. But, that shouldn't be much of a concern.

AT&T's anticipated capital expenditures are actually less than the $20.9 billion spent last year, when AT&T still generated $13.8 billion in free cash flow. That was more than enough to cover its nearly $10 billion in dividend payments last year.

Additionally, AT&T is selling debt to help boost cash. It sold $2.5 billion in debt earlier this year at very attractive rates. The offering included 30-year bonds sold at a 4.8% interest rate, which is actually lower than its dividend. Analysts expect AT&T to sell as much as $5 billion in additional bonds, after testing the waters of the credit markets and getting favorable results.

The Foolish bottom line
AT&T is reaping huge benefits from its bundled services. But, its ability to maximize this is hindered by the fact that its U-Verse television service isn't yet available nationwide. Bringing in DIRECTV fills the gap, and will allow AT&T to keep high average monthly revenue per user. Even better, the deal shouldn't affect AT&T's ability to maintain its high dividend yield.

Bundled packages are a gold mine for telecommunications companies. It's true that AT&T will benefit from greater customer numbers as a whole, but there's more to the story than that. Looking beneath the surface reveals AT&T's concern about making more money from each user as well, which appears to be the real reason behind the merger.

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