Despite its rapidly growing U-verse video service, AT&T (NYSE:T) still doesn't turn a profit on its nearly 6 million pay-TV subscribers. The problem is that content costs for the relatively new service are too high, while a large percentage of AT&T's subscribers are still on promotional pricing. The company added nearly half a million net subscribers over the last 12 months, not including those subscribers it sold off with its Connecticut wireline properties last quarter.
But that could all change if and when the DirecTV (NYSE:DTV.DL) acquisition goes through. DirecTV will add more than 20 million high-value subscribers to AT&T's arsenal, providing it with added leverage over content companies, as well as synergies in content distribution rights. The result is that AT&T would instantly be able to turn a profit on its pay-TV service.
Bringing on high-value customers
During the third quarter, DirecTV grossed an average monthly revenue per user of $107.27 in the United States. Comparatively, AT&T generates $103.25 per wireline customer, but that includes its voice, Internet, and video subscribers and is skewed by its legacy wireline voice subscribers.
DirecTV is able to achieve such high ARPU because of its ability to sell high-cost programming packages (like Sunday NFL Ticket) as well as its Genie DVR. It also saw a 23% increase in ad revenue in the third quarter, and it's consistently doubled its ad revenue on a year-over-year basis for seven consecutive quarters.
DirecTV isn't immune to the rising cost of programming, though. Most notably, the company agreed to pay $12 billion for the rights to Sunday NFL Ticket for the next eight years. That's a 50% increase over its previous $1 billion-per-year deal with the NFL. It plans to offset those costs with subscription price increases of 5% to 7%.
Beyond football, however, DirecTV saw programming costs per customer increase 5.3% year over year in the third quarter. That's notably less than what the company had planned for, though, and shows the strength DirecTV and its 20 million subscribers bring to the table for AT&T.
DirecTV should enable AT&T to lower the average cost of programming for its customers and slow the increase in costs. That will put it in a position to turn a profit on its growing number of U-verse subscribers.
Synergies beyond content costs
DirecTV also brings a set of digital distribution rights to AT&T that it can sell to wireless data customers. On AT&T's fourth-quarter conference call, CEO Randall Stephenson envisioned customers being able to walk into its stores and walk out "with content available on the devices that they have purchased."
DirecTV launched Yaveo in December, an over-the-top bundle of Spanish language networks. With AT&T's plans to expand into Mexico and Latin America, those content rights could become extremely valuable as it courts more of the Hispanic market.
The addition of DirecTV's subscribers will also provide leverage for AT&T to negotiate digital distribution rights of more popular networks for both its pay-TV subscribers as well as a potential over-the-top service. Stephenson believes it's inevitable that the traditional cable bundle crumbles, and the DirecTV acquisition puts both businesses in a better position to hedge against cord-cutters or cord-shavers.
A transformative acquisition
The acquisition of DirecTV will make AT&T's residential wireline business bigger than its wireless segment. It will also boost its growing presence in Latin America in combination with its acquisitions of Nextel Mexico and Iusacell, creating another fast-growing business.
For the full year, AT&T guided for EPS growth in the low single digits in 2015. Analysts currently project EPS growth of just 1.2% for the year. While the DirecTV acquisition will curtail earnings to a certain degree, the positive synergies are expected to at least offset the costs of the acquisition. DirecTV should help it grow profits in its existing wireline business, and could present a revenue opportunity for its wireless business with increased data sales. Expect analysts to revise those estimates when the merger is approved.
Adam Levy has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.