AT&T (NYSE:T) took a big step toward cutting the cord on its pay-TV business. It's spinning off its DIRECTV, U-Verse, and AT&T TV businesses into a new company with private equity firm TPG. AT&T will retain 70% ownership of the new company, but it will get a much-needed cash infusion as part of the deal, valuing the business at $16.25 billion. It's not an ideal end result from AT&T's $67 billion DIRECTV acquisition from 2014, but it's necessary for AT&T to move forward.
Finally getting a deal done
AT&T has been under pressure to sell its pay-TV business ever since activist investor Elliott Management took a $3.2 billion position in the company in 2019. Elliott posited AT&T's acquisition strategy not only left it burdened with debt, but also caused distractions leading to operational underperformance.
CEO John Stankey has been divesting assets wherever there's an opportunity. He got rid of the company's anime streaming service Crunchyroll, some of its European media business, and its digital video distribution technology Quickplay, among other assets. But finding a buyer for the struggling pay-TV business proved difficult.
Stankey said AT&T explored "every possibility under the sun" to figure out what to do with its TV business. In the end, Stankey made the best deal available, even if it's not particularly appetizing. AT&T is selling a 30% stake in its entire portfolio of U.S. pay-TV services, including the digital-focused AT&T TV. It's keeping its Latin American satellite TV business.
The deal includes a cash investment from TPG of $1.8 billion, and the new DIRECTV will hold $6.2 billion in debt. That gives AT&T a cash infusion of $7.6 billion and it can move $200 million of debt to the new company's books.
Giving up more for less
It's worth noting the spinoff will include the entirety of AT&T's U.S. pay-TV portfolio: DIRECTV, U-Verse, and AT&T TV.
AT&T TV folded in its over-the-top video subscribers from DIRECTV Now, which became AT&T TV Now, before AT&T stopped selling it. And while the digitally distributed pay-TV service has been shedding subscribers alongside AT&T's satellite and U-Verse subscribers, management had previously said it's an important part of its overarching video strategy. The company planned to use a single technology back end for AT&T TV and HBO Max, leading to greater operating leverage for the services.
It looks like those plans are no longer in the cards, as AT&T had to give up the over-the-top service along with its traditional services to get a deal done. It's hard to fault TPG or any other investor for refusing to do a deal without it. Virtual multichannel video programming distributors (MVPDs) like AT&T TV hold the most promise in the pay-TV space, but even the most popular aren't immune to the overarching cord-cutting trend. With AT&T TV now part of the new DIRECTV spinoff, it complicates the matter of integrating the service with HBO Now.
AT&T needs the cash
AT&T remains committed to paying down its debt, but it also just committed $23 billion to the FCC for new spectrum licenses for its 5G network. It tapped Bank of America for a $15 billion loan to help pay for the spectrum, so the $7.8 billion net improvement coming to its balance sheet after the spinoff closes still won't even cover the new debt. AT&T will have to use its free cash flow to cover the excess, which means it may not de-lever at all this year.
Additionally, AT&T is investing in HBO Max, its premium streaming service. Management plans to expand the service to Latin America later this year, and it's also increasing content investments. At its 2019 investor day, management said it expects to spend an extra $2.5 billion on HBO Max in 2021 and lose $1 billion. The algebra may have changed this year, after AT&T made the decision to release its entire WarnerMedia film slate directly to HBO Max.
But the wireless business and HBO Max are the focus of the company going forward. And with the pay-TV business mostly out of the picture, management can actually provide the attention those two products require.