AT&T's (T -2.22%) television business has struggled over the past year or so, as it looks to clean up its customer base after heavy promotions from a couple of years ago. Customers on loss-leading promotional pricing aren't sticking around once their promo periods end, and AT&T is fine with letting them go. Investors might expect the company's Entertainment Group EBITDA margin to expand as a result of retaining more profitable customers, but the mounting customer losses actually led to shrinking margins last year.
The company expects flat EBITDA this year, however, and its plans for a new DIRECTV service will be instrumental in getting it there. The company will launch its "thin-client" DIRECTV service in the third quarter, CEO John Donovan said at the Credit Suisse Communications Conference. Donovan thinks it's going to "radically reshape" television, and it'll "really be disruptive." It might improve the business' EBITDA margin, but it's hard to see it dramatically improving the overall trend of customer losses and declining service revenue.
Satellite TV without the satellite
The idea behind AT&T's new DIRECTV service is that it offers the same features as the DIRECTV satellite service, but without the need to install a satellite. Instead, customers will be able to self-install a custom set-top box that connects to the internet. AT&T will stream video through the box to customers' TV sets. It's very similar to T-Mobile's (TMUS -1.20%) TVision Home service announced earlier this year.
Using self-installed hardware and delivering channels over the internet provides a couple of big advantages for AT&T over its satellite service. First of all, self-installation cuts down on the expense of installing a satellite and connecting it to a customer's televisions, lowering customer acquisition costs.
Second, and perhaps more importantly, delivering service via the internet means there's no more line-of-sight issues with satellite reception. "Roughly 20% of U.S. households for one reason or another can't get satellite," Donovan said. This move expands DIRECTV's addressable market and makes its nationwide marketing spend and wireless bundling strategies more efficient.
Overall, AT&T could see significant improvements in the total up-front costs for new customers.
A more competitive market
Driving down customer acquisition costs and improving marketing efficiency should improve the business' profit margin, but those improvements could be offset by the growing number of video options available to consumers.
T-Mobile notably priced TVision at $100 per month for a premium package of channels and features designed to go head to head with DIRECTV and other premium TV offerings. AT&T's average revenue per subscriber was $115 per month last quarter. T-Mobile has big plans to offer TVision to a wide swath of the United States, and it could put pricing pressure on DIRECTV, eroding the potential margin improvements.
Meanwhile, DIRECTV still has to compete with virtual pay-TV providers like Disney's Hulu. It offers its own virtual service, DIRECTV Now, but the company recently raised its price and removed channels, making it much less competitive by comparison.
Donovan even makes a case for the smaller bundles offered by the virtual providers: "The average customer [is] saying I only want to watch 12 [channels], so not only do I not want to pay for the 300 [channels]; I don't want to have to mine through the 300." If the average consumer can get everything he or she wants from Hulu for just $45 per month, that customer isn't going to bother with AT&T's thin client. Hulu is also well positioned to keep its price low.
For what it's worth, Donovan doesn't seem interested in eking out low margin on the television business: "We went through a period of time where we tried to squeeze in everything that was there and just put it into a smaller, lower price point. And I don't think that's going to ultimately be the solution." The DIRECTV thin client will enable AT&T to produce better margins or stay competitive with more high-end competition, but it won't solve the secular trend of customers who are flocking toward lower-cost streaming options.