AT&T's (NYSE:T) entertainment business was a big weak spot in the company's third-quarter results released this week. The largest pay-TV provider in the country lost 297,000 subscribers across its various television services -- DirecTV, U-Verse, and DirecTV Now.
Satellite subscriber losses, specifically, increased to 359,000 from 251,000 in the third quarter last year. Meanwhile, DirecTV Now subscriber gains fell to just 49,000 from 296,000 last year. Both results are tied to one common theme: price increases.
Many satellite customers came off a two-year price guarantee they received in 2016, which resulted in many balking at the higher bills they received. At the same time, AT&T increased the price on each of its DirecTV Now plans by $5 per month. But even with a focus on profitability, AT&T saw profits for the entertainment segment fall.
Nobody wants to pay that much for TV
AT&T saw a sequential increase in its average revenue per user in its traditional TV services, from $113.69 per month to $116.49 per month. That's still down from the $122.27 customers paid on average in the third quarter last year.
That number also doesn't include AT&T's over-the-top subscribers, who typically pay less than traditional TV subscribers. DirecTV Now starts at $40 per month, and the new Watch TV service is just $15 per month but more likely bundled with one of AT&T's phone plans.
AT&T's management wouldn't say exactly whether the company saw increased subscriber churn or if it saw fewer gross additions. Commentary about its promotions surrounding DirecTV Now attracting low-value customers, however, suggests that it saw fewer gross additions without offering things like free streaming devices to new customers. It's likely the satellite business saw customers end their service after lapping their two-year promotional pricing.
AT&T faces a ton of competition from over-the-top competitors like Hulu Live and Alphabet's YouTube TV. Both charge the same $40 per month as DirecTV Now, but Hulu Live includes access to Hulu's on-demand service and 50 hours of DVR storage, and YouTube TV includes unlimited DVR storage. (DirecTV Now offers only 20 hours of DVR storage.) DirecTV will have a hard time competing with others in the space without any notable advantage.
Where are the profits?
AT&T is raising prices on video customers, including about 1.9 million DirecTV Now subscribers, but the segment's profitability is declining. Video revenue fell 7.25% year over year, adjusting for accounting changes this year.
Moreover, the company's operating income margin fell nearly 3 percentage points year over year to 7.4% from 10.3%. Earnings before interest, taxes, depreciation, and amortization margin fared only slightly better, down 2.7 percentage points to 18.7%.
Management points to factors like an extra week of the expensive content rights for NFL Sunday Ticket. But AT&T saw margin compression last year as well. The continued increase in content costs is an ongoing challenge for AT&T's television businesses, and investors shouldn't expect much respite in the future.
Management said it's looking into offering bundles of content that suit the needs and wants of its customers, potentially reducing its content expenses. But as long as competition from companies like Hulu, YouTube, other digitally native offerings and dozens of subscription video on demand services remain fierce, AT&T will likely sacrifice subscribers for the benefit of lower content costs. That could improve margins, but on a lower revenue base -- one that's already shrinking considerably every year.
AT&T has more television subscribers than anyone else in the industry. But those subscribers are becoming less and less profitable every year. Raising prices has only managed to make matters worse for the company, as subscribers now have plenty of less-expensive alternatives. Keeping prices low isn't an option, either, as AT&T can't make a meaningful profit at its old prices.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares). The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.