AT&T (NYSE:T) is one of the most acquisitive companies around. Its proposed takeover of DirecTV (NYSE:DTV.DL) will go down in history books as its second-largest (AT&T paid $67 billion for the BellSouth takeover), and one of the industry's largest in recent times. To achieve this feat, however, the telecom behemoth will have to clear a few hurdles.
AT&T's chief executive, Randall Stephenson, appeared before the Senate Antitrust Committee on June 24, 2014 to defend his proposed merger. One of the pledges he made was that the carrier will help bring broadband connectivity to 13 million under-served rural homes in America. However, this was not the first time AT&T played the rural broadband connectivity trump card in a bid to win over regulators.
What are the chances of the takeover seeing the light of day?
Whether or not the proposed DirecTV merger will pass antitrust screening by the FCC and the Department of Justice remains to be seen. In 2011, AT&T withdrew its attempted $39 billion takeover of T-Mobile after facing stiff opposition by regulatory bodies due to antitrust concerns. Back then, AT&T touted its ability to service more rural customers through the broader reach of the merged company. The carrier even pre-emptively committed itself to cover virtually every American with high-speed wireless technology, aka LTE.
Investors should bear in mind that the AT&T deal will be scrutinized by regulators both from a company and an industry viewpoint. AT&T recently argued its case before the FCC, claiming that its content acquisition costs are significantly higher than those of rivals, since its U-Verse video service has only 5.7 million subscribers; DirecTV has 20 million pay-TV subscribers.
The merged company will, therefore, boast almost 26 million subscribers, 5 million more than Comcast's 20 million. Mr. Stephenson told the Senate Antitrust committee that the merger will help slow down increases in programming prices, but said that he couldn't promise that it would lead to lower prices for customers.
But, Comcast (NASDAQ:CMCSA) has also proposed a merger with Time Warner, while Sprint has set its eyes on a T-Mobile takeover. Hoping for three mega mergers in related industries to all win regulatory approval simultaneously might be asking for too much.
The AT&T/DirecTV deal, however, involves merging two companies in different verticals in a move that might increase competition in the industry. AT&T will be sure to drive this point home before the FCC. The Comcast/Time Warner deal will, ironically, also have a good chance of seeing the light of day if the AT&T merger is approved, as it will lessen concerns about the company dominating.
Benefits of the AT&T/DirecTV merger
AT&T's revenue growth has not been very impressive in recent times. The carrier's top line expanded just 1.9% in fiscal 2013. According to Jeffries, however, revenue for the combined entity is expected to grow at a CAGR of 2.9% through 2016.
But, that could be a conservative estimate. AT&T will now have a good opportunity to cross-sell to customers by bundling services such as mobile plans and Internet together with pay-TV services. Bundling services is a clever way of getting the most out of a company's existing subscriber base. Comcast has been using this trick successfully for a number of years now. The cable giant bundles voice, Internet, and video services into one package that typically costs less than the sum of the three separate services.
AT&T could see substantial cost savings through increased cost efficiency after the merger. DirecTV currently spends approximately $873 to acquire one new customer, of which nearly 12% is related to the cost of set-top boxes, while the rest goes to cover labor costs, marketing costs and so on. If AT&T manages to get 45 million of its non-DirecTV customers to sign up for DirecTV (70% of AT&T's 65 million non-DirecTV post-paid subscribers) at not more than half that cost, the cost synergies are significant.
Foolish bottom line
A merger between AT&T and DirecTV seems likely, as it would be counterbalanced by the Comcast/Time Warner merger. Whether AT&T will honor its pledge to provide broadband to rural America is a different matter altogether.