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Warner May Have Been Out of Place at AT&T, But It Was Still Profitable

By James Brumley - May 21, 2021 at 8:43AM

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AT&T pulling the plug on video entertainment to focus on telecom makes sense, but now's not the best time to make such a deal.

AT&T (T 0.63%) CEO John Stankey didn't say as much, but AT&T's recent decision to sell its WarnerMedia unit to television production outfit Discovery (DISC.A) (DISCK) at a loss less than three years after it was acquired speaks volumes. Good riddance, he seems to be subtly suggesting.

But before cheering the fact that AT&T will now be able to better focus on its core telecom competency, know that WarnerMedia was by no means a drag on the company's bottom line. Quite the contrary, actually. Not only is the film and TV media unit surprisingly profitable, its young HBO Max product is a legitimate streaming contender that could have evolved into a key profit center. The company is actually giving up a lot by bailing out of the entertainment business now.

Here's how much it's giving up.

Man counting cash at a table.

Image source: Getty Images.

Crunching the numbers

One should be wary of using 2020 as a yardstick for AT&T's results for the obvious reason -- there was nothing normal about the COVID-crimped year. A more meaningful comparison is found in 2019's figures, which is the first full year AT&T owned Warner.

In 2019, WarnerMedia accounted for $35.2 billion of companywide sales of $181.2 million and generated $11.1 billion in EBITDA (earnings before interest, taxes, depreciation, and amortization). That's 18% of the year's total EBITDA of $59.3 billion, versus Warner's contribution of 19% of AT&T's total top line. All in all, not bad.

WarnerMedia accounts for 19% of AT&T's 2019 revenue, and 18% of its EBITDA.

Data source: AT&T. Chart by author. All dollar figures are in millions.

Even so, while the pandemic up-ended Warner's movie business, it also boosted HBO's reach. WarnerMedia's overall 2020 revenue peeled back by nearly 11% to $30.4 billion, driving EBITDA similarly lower to just under $8.9 billion. Consider the circumstances, though. That's still a respectable showing, roughly in line with the previous year's numbers and pointing to the unit's resilience and flexibility.

In 2020, 18% of AT&T's revenue was driven by WarnerMedia, and 16% of its EBITDA came from the film and TV unit.

Data source: AT&T. Chart by author. All dollar figures are in millions.

Now it's all going away.

It's not all bad news, to be clear. AT&T will collect $43 billion from Discovery for WarnerMedia. Stankey didn't explicitly indicate this full amount would be used to pay down AT&T's current long-term debt load of $160.7 billion. He has, however, frequently discussed hopes of whittling down the company's debt load since taking the helm in July of last year. Assuming the entire $43 billion in proceeds is used to pay down debt, AT&T's annual interest payments of just under $8 billion should slide back to somewhere around $5.8 billion -- a savings of just over $2 billion per year.

That's a big "if" of course, and regardless, AT&T walks away from the sale smaller by about $7 billion worth of yearly profit.

What might have been

While there's a finite fiscal impact to Warner's impending absence in store, there's also a more ambiguous lost opportunity associated with the sale.

It's not inconceivable that the HBO brand would have grown to the company's target of between 120 million and 150 million subscribers before the end of 2025. At that headcount -- assuming last quarter's average monthly per-user revenue of $11.72 is the new norm, HBO itself could have been nearly a $20 billion business, well up from last year's total revenue of $6.8 billion. Even Stankey himself has been touting his high hopes for HBO Max, plainly saying several times over the past few months he was sure all the moves being made would eventually pay off.

And that's just HBO, for the record. WarnerMedia includes Turner Broadcasting and Warner Bros. movies. Remember, this whole arm's still generating in excess of $30 billion worth of annual revenue, and had yet to fully benefit from being cross-marketed with other AT&T services.

Then there's the even less tangible benefit of keeping Warner in the AT&T family: Using it as a customer conversion and retention tool. Several of its higher-end wireless plans and DIRECTV packages included free access to HBO Max. It's not clear to what extent this offer was helping, but to the extent it was, it won't continue to do so past next year when the Discovery/Warner deal is expected to close.

Bottom line

Still, not all is lost.

Discovery is the name behind several lifestyle channels like HGTV, Animal Planet, Travel Channel, Food Network, and others. It also ended Q1 with 13 million streaming subscribers with a fairly young suite of streaming services. WarnerMedia's higher-profile content like DC's Justice League characters and HBO's Game of Thrones adds some octane to whatever mix the combined company might decide to offer. There's also the upside of being able to focus on doing one thing exceedingly well -- telecom in this case -- rather than juggling different sorts of profit centers.

To this end, any owners of AT&T who stuck with the stock through Monday and Tuesday's 8% rout may as well continue holding it. You'll collectively be receiving about 70% of what's sure to be an impressive streaming and cable force once the spin-out is complete.

Nevertheless, it would have been interesting to watch AT&T leverage the successful streaming video product it had finally put together. HBO Max was just starting to hit its stride, and the company might have been able to avoid locking in what's essentially a $40 billion loss on Warner in less than three years. Indeed, AT&T's actually in a much deeper debt hole now than it was then ... relative to its revenue potential, anyway.

As the old saying goes, timing is everything.

James Brumley owns shares of AT&T. The Motley Fool recommends Discovery (C shares). The Motley Fool has a disclosure policy.

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