The latest quarterly results from AT&T (T -2.29%) made a lot of demands on investors to sustain confidence in the company's future path. Looking at its quarterly conference call, management urged the audience not to mind the 544,000 net subscriber losses from our premium TV segment. Investors were supposed to ignore the 83,000 low-to-no-profit DIRECTV Now subscribers the company lost, too. And the 117,000 additional subscribers we would have counted as losses if not for a billing change -- not a huge concern either.
Instead, AT&T would much rather focus on the growth of its entertainment group's EBITDA (earnings before interest, taxes, depreciation, and amortization) and the average revenue it brings in per TV subscriber. DIRECTV Now subscribers paid an average of $10 more per month for the service last quarter than they did in the first quarter last year, and premium-TV subscriber ARPU (average revenue per user) increased 2.2%. EBITDA for the segment was higher by 7%.
AT&T's strategy of focusing on higher-paying customers resulted in improved profitability for the entertainment group. But is the strategy sustainable?
We knew this was coming
AT&T enacted its annual price increase for its premium pay-TV services -- DIRECTV and U-verse -- in January this year. It also raised the price of DIRECTV Now to a minimum of $50 per month at the end of the quarter, while decreasing the breadth of networks in its channel packages.
The increase in pricing led some customers to defect from AT&T's services, but likely had an even bigger impact on gross additions. AT&T also pulled back on promotional spending for its pay-TV services, also negatively impacting gross additions. It no longer offers as much promotional pricing to get customers to sign up, for example.
Many customers are still on two-year promotional pricing plans, and 1.6 million premium-TV subscribers are still getting a discount on their monthly bills. Over 700,000 came off that promotional pricing in the first quarter.
As AT&T lets those price promotions lapse, it'll continue to see relatively high churn. Management says that most of the 1.6 million customers still on promotional pricing will come off this quarter, and the rest will be completely done by November.
As a result of its decisions regarding price promotions, AT&T will see higher churn and fewer gross additions, which ought to generate continued net losses throughout 2019. The upside is that the customers it's keeping are more profitable. Management noted that low-end customers are more likely to churn than high-paying ones.
Weakening long-term potential
AT&T is building media and advertising businesses -- WarnerMedia and Xandr -- that work closely with its entertainment group. Both of those businesses benefit from maximizing their audiences, and AT&T spent a lot of money to acquire them.
Interestingly, AT&T isn't really doing anything to benefit those businesses by utilizing its power as the largest pay-TV distributor in the United States. Instead, it's letting customers leave the pay-TV ecosystem, as it searches for short-term profitability directly from subscription revenue.
That leaves AT&T without much long-term growth potential for its entertainment business. It can't keep raising prices indefinitely, and without promoting its services it won't sign up any new customers outside of areas where it's the only option for pay TV. That monopolized market is rapidly shrinking as more customers gain access to high-speed internet.
AT&T won't be able to sustain EBITDA growth in its entertainment segment merely by cutting costs and letting low-value subscribers leave the service. The company needs to find a way to extract more value from subscribers without them paying for it on their monthly bills. That's a challenge AT&T has faced for years now, and it can't find a solution. The premium pricing is merely a bandage to cover up the underlying challenge it faces: Consumers continue to cut the cord. We might see EBITDA improve throughout 2019, but declining subscribers will limit growth for the next decade.