Earlier this month, AT&T (T -1.13%) announced that it ended 2021 with 73.8 million HBO Max subscribers. That number surprised investors, as the company guided for 70 million to 73 million in July. But there were some key details missing from the press release.
Following the company's fourth-quarter earnings report last week, we now have a better understanding of what's going on beneath the headline numbers at HBO Max, and there are three things investors should pay close attention to.
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1. Total revenue
WarnerMedia's direct-to-consumer business, which consists primarily of HBO Max, saw its total operating revenue decline more than 6% sequentially. That's a confounding result considering it added 1.6 million domestic subscribers and 2.7 million more internationally.
When asked about the decline during the fourth-quarter earnings call last week, chief financial officer Pascal Desroches pointed to HBO's previous distribution deal with Amazon (AMZN -1.33%). The company removed HBO from Amazon Channels near the end of the third quarter, resulting in around 5 million customers losing access through the service. HBO looked to reengage those customers and get them to sign up directly through HBO Max, offering temporary promotion pricing for a few weeks after the distribution agreement ended.
"We're going to be decelerating as a result of Amazon," Desroches said. "It is a one-time decline."
To be sure, HBO collected revenue from Amazon Channels customers for most of the third quarter. However, it didn't collect the full amount. Amazon takes a 30% to 50% cut of Channels revenue, although HBO was very likely on the lower end.
It could be that despite ending the third quarter with fewer domestic subscribers than it ended the fourth quarter with, its average subscribers throughout the third quarter were actually higher because Amazon subscribers didn't drop off until September. That could result in more revenue throughout the third quarter.
Investors will want to watch this number and ensure it bounces back quickly.
2. Average revenue per domestic subscriber
While some timing around subscriber churn might explain the drop in total revenue for HBO Max, it can't explain the drop in average revenue per user (ARPU). ARPU is reported on a monthly basis, so churn throughout the quarter is irrelevant. Nonetheless, domestic ARPU fell nearly 6% from $11.82 in the third quarter to $11.15 in the fourth quarter.
Digging into the footnotes of AT&T's earnings report reveals how management defines ARPU: "Domestic HBO Max and HBO Subscriber revenues during the period divided by average Domestic HBO Max and HBO Subscribers during the period."
That's all well and good, except HBO Max now has an ad-supported version of the service, which it launched in June. It's unclear if ad revenue goes toward the ARPU calculation, but the wording suggests it doesn't. However, the standard among streaming services is to include ad revenue in the calculation.
Management says it's indifferent to whether a customer signs up for the ad-free or ad-supported version -- they generate similar total revenue. But management expects more people to sign up for the ad-supported version in the future. That's because there's no longer a big difference in content between the two, since the company is ending the same-day release of Warner Bros. films in theaters and on ad-free HBO Max.
If it doesn't include ad revenue in its ARPU calculation, ARPU should continue to decline. But investors should see the content and other revenue line item (which includes ad revenue) rise sharply. But we didn't see a significant rise in that item in the fourth quarter.
3. EBITDA
WarnerMedia's direct-to-consumer business reported negative earnings before interest, taxes, depreciation, and amortization (EBITDA) for the first time. Operating revenue totaled just $2.1 billion while expenses climbed to $2.3 billion.
Management said 2022 will be the "peak investment year for HBO Max" during the earnings call. When asked to clarify whether that meant it will produce negative EBITDA all year, management didn't provide a definitive answer.
If EBITDA remains negative, investors will want to see subscriber growth that justifies the investments the company is making. A lot of that growth may come from international markets where its pricing is lower, but the potential for long-term growth is higher. So it would be reasonable for EBITDA to stay negative if the potential for future profits improves throughout the year.
While the headline result for HBO Max was great, digging deeper into the numbers produced a lot of questions without clear answers. If the picture doesn't become clearer over the next couple of quarters before AT&T spins off the business, it might be best to avoid the business and look elsewhere in streaming media.
