AT&T (T 1.54%) had plans under former CEO Randall Stephenson to create an ecosystem of entertainment, internet, and phone services to help the company attract and hold on to customers in the highly competitive U.S. telecom market. To that end, it acquired Time Warner, now dubbed WarnerMedia, in 2018.
Current CEO John Stankey, brought on last July, ended the company's media foray on May 17 with the announcement that AT&T's WarnerMedia assets would combine with Discovery Communications (DISC.A +0.00%) (DISCK +0.00%) to create a new entertainment company.
Does this mean AT&T's entertainment bet was a bust? A look at WarnerMedia's contributions over the past several quarters reveals the answer, and they point to how the deal with Discovery benefits shareholders.
Image source: Getty Images.
WarnerMedia's contributions
WarnerMedia bolstered AT&T's telecom business amid the coronavirus pandemic. AT&T kicked off 2021 with a solid first quarter as WarnerMedia contributed $8.5 billion to the company's $43.9 billion in revenue, a 2.7% year-over-year increase.
Theater reopenings and a resurgence in advertiser spending enabled WarnerMedia first-quarter revenue to rise nearly 10% from 2020's $7.8 billion. Its contributions during the pandemic go back to the second quarter of 2020, when it launched its marquee streaming video service, HBO Max, on May 27.
HBO Max helped AT&T experience strength in key metrics. The competitive nature of the U.S. telecom industry makes smartphone customer acquisition and low churn crucial to success, particularly in the valuable postpaid subscriber category. AT&T's performance in these metrics has been stellar since the HBO Max launch.
| Quarter | Postpaid Net Adds/(Drops) | Postpaid Churn |
|---|---|---|
| Q1 2021 | 823,000 | 0.93% |
| Q4 2020 | 1.23 million | 0.94% |
| Q3 2020 | 1.08 million | 0.85% |
| Q2 2020 | (154,000) | 1.05% |
| Q1 2020 | 27,000 | 1.08% |
Data source: AT&T.
This is no small feat. Consider rival Verizon's first-quarter postpaid net loss of 170,000 against AT&T's 823,000 net adds. As Stankey pointed out, it's not promotions that pulled in customers. AT&T's "average promotional spend per net add is significantly lower than a year ago," he stated during the first-quarter earnings report.
The company bundles HBO Max with its higher-priced wireless subscription plans, driving adoption up while reducing churn. Stankey noted, "We know that when we bundle, we drive churn down." That's why he plans to retain HBO Max as part of AT&T's offerings after the WarnerMedia spinoff, describing AT&T as a strategic partner for the new entertainment company.
HBO Max growth
Given this success, spinning off WarnerMedia was the right move for investors to unlock the division's full potential. AT&T shareholders will receive stock representing 71% of the new media company.
This new entertainment firm provides excellent growth opportunities for shareholders. Since HBO Max's second-quarter launch, HBO subscribers and its direct-to-consumer revenue have grown every quarter and now surpass pre-pandemic numbers.
| Quarter | Global HBO Subscribers | Direct-to-Consumer Revenue |
|---|---|---|
| Q1 2021 | 63.9 million | $1.93 billion |
| Q4 2020 | 60.6 million | $1.90 billion |
| Q3 2020 | 56.9 million | $1.78 billion |
| Q2 2020 | 55.6 million | $1.63 billion |
| Q1 2020 | 53.8 million | $1.50 billion |
| Q4 2019 | 54.7 million | $1.70 billion |
Data source: AT&T.
HBO Max's consistent subscriber growth will only continue. The service has yet to fully roll out internationally. As Stankey said about the Discovery deal, "It will support the fantastic growth and international launch of HBO Max with Discovery's global footprint."
The new company will also have rising consumer adoption of over-the-top (OTT) streaming video as a tailwind. OTT revenue is forecast to more than double from 2019's $83.3 billion to $167.4 billion by 2025.
The WarnerMedia spinoff means AT&T can focus on its core telecom business. AT&T generated free cash flow of $5.9 billion in the first quarter, up 51% year over year. It will need these funds to continue aggressive investment in its 5G network while paying out its dividend, which cost the telco $3.7 billion in the first quarter.
The bottom line
Speaking of the dividend, AT&T's deal with Discovery means investors who jumped into AT&T stock for its dividend will experience a drop in income. The dividend will be adjusted to account for WarnerMedia's distribution to shareholders.
Understandably, this creates some short-term pain for investors. But once the deal closes around mid-2022, the new company is projected to reach $52 billion in revenue by 2023. That's a significant step up from the $39 billion a combined WarnerMedia and Discovery would have earned in 2020, of which WarnerMedia comprises about $30 billion.
In the long run, investors can anticipate that the growth of the combined WarnerMedia and Discovery will make it a formidable entertainment empire, creating a positive investment for shareholders.
