Hulu didn't launch its Hulu Live TV service until nearly six months after AT&T (NYSE:T) brought DirecTV Now to market. Yet, despite AT&T's numerous efforts to get customers to sign up for its virtual linear TV service, poor fourth quarter results left it with about as many subscribers as its smaller competitor, according to The Diffusion Group.
AT&T has taken to giving out free streaming hardware, free or discounted premium channels like HBO, and bundling discounts to its wireless phone subscribers. While the promos worked to attract customers, AT&T hasn't been able to hold onto them after its promotions have ended.
In the meantime, Hulu has steadily added new subscribers to its Live TV service over the last 18 months without significant promotions. Here's how the small company surpassed the biggest pay-TV company in the country, and why it matters to both AT&T and Hulu's owners, primarily Disney (NYSE:DIS).
Willing to take losses
It's no secret that neither DirecTV Now or Hulu Live is a profitable endeavor. AT&T tries to obfuscate the numbers surrounding DirecTV's average revenue per user and profit margin, but a little back-of-the-envelope math indicates the gross margins are likely negative. Meanwhile, Hulu's owners reported significantly larger losses from their equity investments in 2018 than in 2017.
Hulu certainly seems more willing to sustain losses from its live TV service than AT&T.
The latter made moves to remove DirecTV Now subscribers that were still on promotional pricing from its launch or its previous wireless bundling offers. Some subscribers were effectively paying as little as $10 per month for the service. Getting rid of promotional pricing led to a loss of 267,000 subscribers in the fourth quarter.
AT&T is also purposefully diminishing the value of DirecTV Now as it prepares to launch a new video service this year. CEO Randall Stephenson used the phrase "thin the content out" at the UBS Global Media and Communications Conference in December.
The idea is to reduce the content costs associated with the lower-price plan while pushing customers to a new service that costs between $50 and $60 per month. Hulu is also considering dropping some live channels, but it plans to move that content to its on-demand platform, which will have a minimal impact on most viewers.
Why Hulu can sustain losses, but AT&T can't
There are a couple reasons Hulu might be more willing than AT&T to take a loss on its live TV streaming service.
First, Hulu's relationship with its owners means a lot of its content costs are more like accounting procedures rather than real cash expenses. AT&T gained some of those benefits after acquiring WarnerMedia, but when Hulu licenses content from Disney, Fox, NBCUniversal, or Turner networks, it just puts money back into the pockets of its owners.
Disney may be willing to keep taking "losses" from Hulu Live TV subscriptions when it takes majority ownership of the company if it means more total subscribers to ESPN. It's effectively a way for Disney to maintain the high price it charges distributors for ESPN and its other networks, but basically giving Hulu a discount as it throws more cash into the streaming business.
The second reason is that Hulu's advertising business is much better positioned than AT&T's. AT&T is still building out technology in its ad platform, Xandr, to support programmatic ad buying for DirecTV Now. Hulu, meanwhile, has been selling digital video ads since its inception.
Hulu grew its ad revenue 45% in 2018 to $1.5 billion and grew active advertisers 50% in 2018. For comparison, Xandr revenue grew less than 27% in 2018, including revenue from AT&T's AppNexus acquisition in August.
Disney also notably owns a majority stake in BAMTech, the streaming back-end that powers Hulu Live. Combined with rapidly improving ad technology and strong growth in demand for Hulu ads, the smaller company is poised to see greater benefits from scale compared to AT&T thanks to greater vertical integration.
What it all means for investors
Disney investors should expect the company to continue making efforts to scale the Hulu Live service while taking losses in the short term. Those losses will show up in Disney's new Direct-to-Consumer and International segment.
But Disney will also benefit from a strong buyer of its cable networks, so investors should see continued growth in the Media Networks segment. That segment has maintained revenue growth over the past few years, but operating income has declined as content costs increase at a faster pace. Adding Hulu Live as a significant buyer could bolster pricing for Disney's cable networks with other distributors.
Meanwhile, AT&T subscribers might see the company look to make its video service more profitable, likely at the expense of subscriber growth. We're already seeing management focus on more profitable subscribers. That may be to AT&T's long term detriment, however, as its scale in pay-TV gives it considerable buying power in negotiations with media companies, including Disney. That could ultimately cut into its profit margins leading to a vicious cycle where it's continuously focusing on reducing its unprofitable subscribers instead of figuring out other ways to reduce costs.