AT&T (NYSE:T) will launch two new streaming video products next year: the highly anticipated HBO Max on-demand service and a linear TV streaming product simply called AT&T TV. In the meantime, however, the largest pay-TV provider in the U.S. lost a record number of subscribers in the third quarter. Nearly 1.4 million customers left AT&T's various pay-TV services over the three-month period, including 195,000 AT&T TV Now streaming subscribers.
The good news is management believes subscriber losses have peaked. It faced several headwinds in the third quarter that won't be as bad in Q4 and beyond. Those challenges include network blackouts from Nexstar and CBS, to which management attributed 225,000 net losses. It's also seeing customers come off of their two-year promotional pricing, which will wrap up in November. On top of that, gross additions have been pressured by higher introductory pricing and credit thresholds for new customers.
The pressure on customer losses will ease up going forward, but as far as adding new customers, it's all about HBO Max and AT&T TV.
A streamlined and simplified product portfolio
Over the last couple years, AT&T's video product portfolio has gotten quite complex. CEO Randall Stephenson said he wants everyone to be able to find a product that fits their needs with AT&T.
But he had a change of tune during the third-quarter earnings call with analysts. The future video product portfolio at AT&T will be "streamlined and simplified," Stephenson said.
The DIRECTV satellite television business isn't going anywhere. He noted it still generates more than $4 billion in free cash flow every year. DIRECTV still had over 19 million subscribers as of the end of 2018, but it accounted for all of AT&T's premium TV subscriber losses last year. That trend likely continued in 2019, but AT&T no longer breaks out its DIRECTV and U-Verse products.
Aside from satellite, the company intends to focus on its AT&T TV product for consumers looking for a linear TV product going forward. It will use a thin-client set-top box to receive live TV delivered over the internet. The idea is to deliver a premium television experience like DIRECTV, but to be able to do so at a lower price point. AT&T TV install costs are considerably lower than DIRECTV (no satellite installation, no home visit), which means it can offer better pricing and still produce wider profit margins.
The company expects HBO Max to be "the workhorse for our video product." It's investing about $2 billion in the service this year, and it will continue to invest $1 billion to $1.5 billion per year through at least 2022 based on AT&T's three-year outlook. It sees 50 million domestic subscribers signing up for the service within five years, which would put it on par with other big over-the-top services competing for consumers' discretionary spending budgets.
A focus on profitability
A more focused video product portfolio could be a more profitable product portfolio. Notably, AT&T's focus on delivering video over the internet will allow it to produce synergies between HBO Max and its linear TV service. With its expectations for HBO Max, AT&T could see the marginal cost for delivering video for future AT&T TV customers shrink considerably. That could enable it to expand its profit margin or keep its prices low enough to retain and attract customers.
Down the road, management says it expects to incorporate live TV into HBO Max. Having a standardized video delivery protocol will make that transition seamless. Ultimately, that means AT&T will have just two products, Stephenson said, which further reduces marketing and sales expenses.
A key part of AT&T's go-to-market strategy with both services is bundling. Management says it's seen strong success in reducing its wireless customer churn when subscribers bundle HBO. A bundle with HBO Max should reduce churn even more. Meanwhile, the company will bundle AT&T TV with its fiber broadband service. Management also sees the opportunity to bundle HBO Max with either AT&T TV or DIRECTV. If management sees the expected uptick in gross additions and subscriber retention from the new bundles, it could be accretive to its bottom line.
While video customer losses will likely continue to pile up in Q4 as AT&T works through the rest of its customer cleanup from two-year price promotions and enacts another price increase for AT&T TV Now, streaming will take center stage in 2020. A more focused product portfolio should make AT&T's video services more profitable at scale, but it'll require a lot of investment to get there. Investors should look for how management plans to get both services off the ground next year.