Will it or won't it? Despite pressure from activist investor Jesse Cohn, AT&T (T 0.16%) initially appeared disinterested in shedding its struggling DirecTV unit. After last Monday's earnings conference call and Tuesday's strategy update for shareholders, though, it appears the telecom giant may be willing to let go of its satellite television arm after all.
The question is, would a buyer be willing to take on the tough rebuilding project at a price AT&T and its investors can live with? The unit's results and fiscal trajectory suggest the company's better bet may well be to try and rekindle its television unit for itself.
Television arm is a sinking ship
Elliott Management's partner and de facto spokesperson for the fund's position in AT&T, Jesse Cohn, made a fair point within the firm's early September letter to the telecom company's board of directors. That is, AT&T acquired DirecTV "at the absolute peak of the linear TV market," shelling out $67 billion (including debt) for the outfit in 2014.
Netflix was around then, and cord-cutting was well under way. The pace of the paradigm shift for the video entertainment industry, however, has been shocking.
Image source: Getty Images.
Few players are more aware of that reality than AT&T. Its total number of video customers has dwindled from a peak of 25.4 million as of the middle of 2018 to only 21.5 million as of the end of September, with Q3's loss of 1.36 million video customers -- satellite as well as on-demand video customers -- suggesting matters are worsening rather than improving.
It's largely this trend that prompted Elliott's involvement in the first place. Cohn and Associate Portfolio Manager Marc Steinberg penned that AT&T "must move past the era of asset accumulation and into one of integration and execution," and added, "Any assets that do not have a clear, strategic rationale for being part of AT&T should be considered for divestment: DirecTV, the Mexican wireless operations, pieces of the wireline footprint, and other assets must all be evaluated as part of this review."
AT&T CEO Randall Stephenson surprised most everyone on Monday, agreeing in premise without explicitly naming units that could be put up for sale. He explained there are "no sacred cows," hinting DirecTV could be sloughed off to a new owner. That is, if the price is right.
Not much of a profit driver
AT&T doesn't divulge specific profit figures for its video business, though it's not difficult to come up with some reasonabl ballpark figures. Of last quarter's $11.2 billion in revenue for the entertainment group unit -- AT&T TV, AT&T TV Now (formerly DirecTV and DirecTV Now), and high-speed internet service -- just under $8.0 billion of it was driven by video. Divvying up the unit's $1.0 billion worth of operating income would imply television-based operating profits on the order of $700 million.
And for the record, last quarter was not only a fairly typical quarter, it extended a long-standing broad downtrend in AT&T's television-related revenue and operating profits.
Data source: AT&T. Chart by author.
That deterioration is taking shape hand-in-hand with the number of video subscribers the company can claim.
Data source: AT&T. Chart by author.
In short, AT&T's current television/video business is driving revenue at an annualized-but-shrinking $33 billion. The unit's annual operating income, if the entertainment group's operating profits are proportional to its revenue mix, is on the order $3 billion. That number is also shrinking too, though, shaving down any hopes the company may fetch a premium price for the unit; acquisition premiums tend to be limited to growing businesses.
A plausible price tag
So what might AT&T expect to get for its video business? It's only for scope and perspective, but in 2014 then-to-be-acquired DirecTV booked an operating profit of $5.1 billion (and net income of $2.8 billion). AT&T's purchase price of $67 billion was 13.1 times operating income. Assuming the same multiple is still applicable, that would put the marketable price somewhere near $40 billion. Alternatively, data compiled by Thomson One and BCG in 2018 determined that in 2017, entertainment and media deals were being done at 16 times the target company's earnings before interest, taxes and depreciation (EBITDA). Telecom acquisitions were being made at 19 times EBITDA. Using more of the former and less of the latter would imply DirecTV could be passed along for a little more than $50 billion.
The back-breaker, so to speak, is the trajectory. It's unlikely another owner would fare considerably better with DirecTV given the cord-cutting trend all cable providers are experiencing. At best a new owner might be able to slow subscriber losses, and then only temporarily. More plausibly, not even rival Dish Network would be able to stop the bleeding; it's dealing with subscriber losses of its own. Adding downward pressure to a potential sale price is the fact that the sale of DirecTV would be a defensive one, driven by the seller. Any buyer is in a good position to negotiate a below-market price.
In that light one can only speculate as to what sort of valuation AT&T's satellite television business would command on the open market. A price of between $40 billion and $50 billion, however, doesn't feel out of line. Indeed, it feels a little frothy given how the telecom giant is being forced toward a sale. Whatever the case, it appears any plausible sale price is less than the $67 billion AT&T paid for it five years ago, plus any additional capital the company has committed to cable television in the meantime.
One thing is for sure, though. If AT&T can't fix its cable television business as it preps to launch its TimeWarner on-demand video product, it's not a distraction worth keeping.
