AT&T (T 0.77%) introduced DIRECTV Now in November last year, and it quickly amassed hundreds of thousands of subscribers. In the fourth quarter, the service's new subscribers accounted for all of AT&T's television subscriber growth.

But AT&T CFO John Stephens says that's the wrong way of thinking about DIRECTV Now. "We're not looking at DTV Now as a replacement for DIRECTV," he said at the MoffettNathanson Media and Communications Summit earlier this week. "We're looking at DTV Now as a way to get customers a service that they wouldn't otherwise have."

That's an important distinction to make, especially considering the huge difference in profit margins between the two products. DIRECTV satellite is an immensely profitable business, while DIRECTV Now has extremely slim gross margins.

That said, AT&T can't have it both ways; it can't report subscriber losses from satellite and U-verse and then say DIRECTV Now made up for them.

"The future of TV is 'NOW'"

Image source: AT&T

The big difference between DIRECTV and DIRECTV Now

Last November, Deutsche Bank analyst Matthew Niknam put out a note estimating DIRECTV Now's gross margin around 5%. By comparison, AT&T's traditional TV business generates a gross margin around 45%.

What's more, traditional TV also has a much higher average revenue per user than DIRECTV Now. Traditional TV subscribers pay an average of $120 per month to AT&T. Comparatively, DIRECTV Now packages max out at $70 per month. So not only is AT&T keeping a smaller percentage of revenue as gross profit, but there's also less revenue to keep.

But DIRECTV Now may make up for its thin gross margin because it's a much less capital intensive business than satellite or IPTV. Customer acquisition costs are much lower as AT&T doesn't have to spend money on installing equipment at customers' houses.

That's the argument DISH Network (DISH) uses for including Sling TV subscribers in its total video subscriber count. Sling TV is DISH Network's over-the-top linear TV service, which starts as low as $20 per month. That's much less expensive than its average revenue per user of $87.

Just as importantly, over-the-top services such as DIRECTV Now and Sling TV are easy to cancel. That means they'll experience significantly higher churn rates compared with traditional TV, but management would argue lower acquisition costs make up for it. Nonetheless, higher churn means a lower expected lifetime value for each customer. Combine that with thin margins, and there's a significant gap in the profitability of an over-the-top subscriber and a traditional TV subscriber.

Given the drastically different profitability of the two products, it makes sense to consider them separate products. DISH shouldn't consider Sling TV subscribers of equal value of a satellite subscriber, nor should AT&T consider DIRECTV Now a replacement for DIRECTV.

But it keeps doing just that

AT&T is talking out of both sides of its mouth. Stephens says the company doesn't consider DIRECTV Now a replacement for DIRECTV, but last year the company reportedly said it expects DIRECTV Now to become its primary TV platform by 2020.

Just ahead of its fourth-quarter earnings report, AT&T said it had "more than 200,000 video net adds, entirely driven by DIRECTV Now." And in its first-quarter report it said, "Total linear video subscribers were down in the quarter; however, DIRECTV NOW subscribers continued to increase."

By juxtaposing the two metrics, AT&T is implying that DIRECTV Now subscribers are indeed a replacement for DIRECTV and U-verse. AT&T doesn't disclose DIRECTV Now subscribers, but at least it also doesn't include them in its total video subscribers as DISH does with Sling TV. Still, it's basically holding up DIRECTV Now to say its video business is doing all right even as it starts to bleed subscribers.

Stephens is right; DIRECTV Now is not a replacement for DIRECTV. But management needs to be consistent with that message.