With AT&T (NYSE:T) closing its acquisition of media giant Time Warner last week, investors will be watching to see how well the telecom company can integrate Time Warner's powerful content assets, including Warner Bros., HBO, CNN, TNT, and TBS, into its business. In theory, AT&T's acquisition looks great. "Combine [these content assets] with AT&T's strengths in direct-to-consumer distribution, and we offer customers a differentiated, high-quality, mobile-first entertainment experience," explained AT&T CEO Randall Stephenson. But will it be as easy as it sounds?
AT&T is up against some tough competition, particularly when it comes to Time Warner's HBO. Chief among its competition, of course, is fast-growing Netflix (NASDAQ:NFLX). But tech companies Amazon, Alphabet, and Apple, are upping their spending on content, too. Will HBO be better positioned to compete with tough competition under AT&T's leadership? John Stankey, the CEO of AT&T's new media unit, believes so.
Hiking its content budget
To better compete with Netflix, HBO will increase its spending on original content, Stankey said in a Bloomberg interview.
HBO would need to spend far more on content to catch up with Netflix. In 2017, Netflix spent about $6 billion on content. This year, Netflix expects to spend about $7.5 billion to $8 billion on content, with an estimated 25% of this spending going toward original content. HBO's budget has paled in comparison. Time Warner allotted over $2 billion to HBO's content spending in 2017, and approximately half of this spending went to original content.
Even if HBO substantially increases its content budget, it may not increase it fast enough to catch up with Netflix. Netflix has credited much of its success to aggressive spending on content, and the streaming giant plans to keep continuing down this path. "We have big plans for content growth. You should expect that to continue," said Netflix CEO Reed Hastings in the company's most recent earnings call.
Meanwhile, HBO's content budget will likely be pressured by the nascent media units at deep-pocketed tech start-ups, as well as the increasingly ambitious streaming plans from other media companies. In 2017, Amazon and Hulu spent about $4.5 billion and $2.5 billion on content in 2017, respectively. Meanwhile, Apple is ramping up its spending on content and is expected to spend more than $1 billion on content ahead of its rumored subscription-TV service. Walt Disney has also ramped up its direct-to-consumer efforts, recently launching streaming service ESPN Plus and planning a Disney-branded service for 2019.
Investors like Netflix's strategy
Investors have rewarded Netflix for its strategy of investing heavily in original content. The stock has soared 158% over the past 12 months and has gained more than 300% over the past three years as the streaming TV giant has grown its subscribers and revenue. Its run-up gave Netflix a valuation well beyond Time Warner's. Netflix's market capitalization is currently about $170 billion -- about double the $85.4 billion price AT&T paid for Time Warner.
The case for HBO to follow Netflix's lead has become even stronger recently. Netflix's streaming year-over-year revenue growth accelerated in its most recent quarter to a growth rate of 43.2% year over year -- and management is expecting this growth rate to rise to 43.8% in its second quarter. In addition, Netflix's profitability is soaring, with net income climbing 63% year over year in its first quarter of 2018.
AT&T will need to really step on the accelerator with its HBO content spending if it wants to avoid falling too far behind.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Daniel Sparks owns shares of Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Netflix, and Walt Disney. The Motley Fool has a disclosure policy.